Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.

12) Two separate firms are considering investing in this project. Firm Unlevered plans to fund the entire $80,000 investment using equity, while Firm Levered plans to borrow $45,000 at the risk-free rate of 5% and use equity to finance the remainder of the initial investment. Construct a table detailing the percentage returns to the equity holders of both the levered and unlevered firms for both the weak and strong economy.

Answer:

	Initial Value	C/F Strong Economy	C/F Weak Economy	Returns Strong Economy	Returns Weak Economy
Debt	$45,000	$ 47,250	$47,250
Levered Equity	$45,000	$ 69,750	$42,750
Unlevered Equity	$90,000	$117,000	$90,000

PV(equity cash flows) =

C/F (weak economy) =

C/F (strong economy) =

Returns =

Expected Return

13) Two separate firms are considering investing in this project. Firm Unlevered plans to fund the entire $80,000 investment using equity, while Firm Levered plans to borrow $45,000 at the risk-free rate and use equity to finance the remainder of the initial investment. Calculate the expected returns for both the levered and unlevered firm.

Answer:

	Initial Value	C/F Strong Economy	C/F Weak Economy	Returns Strong Economy	Returns Weak Economy	Expected Return
Debt	$45,000	$ 47,250	$47,250
Levered Equity	$45,000	$ 69,750	$42,750
Unlevered Equity	$90,000	$117,000	$90,000

PV(equity cash flows) =

C/F (weak economy) =

C/F (strong economy) =

Returns =

Expected return =