Question: Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required for

Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required for the project is $100,000, and the projects cost of capital is 20%. The risk-free interest rate is 10%.

a. What is the NPV of this project?

b. To raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. What is the initial market value of the unlevered equity?

c. Suppose the initial $100,000 is instead raised by borrowing at the risk-free interest rate. What are the cash flows of the levered equity, and what is its initial value according to MM?

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