Consider a rm that produces 10 units of gold a year from today The price of gold next year, S T , is normally distributed with mean 100 and volatility of 20 The rm knows that there will be a buyer who is willing to pay the price of 90 per unit, no matter what the value of S T is At T 1, the rm can ...

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Consider a rm that produces 10 units of gold a year from today. The price of gold

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Consider a ﬁrm that produces 10 units of gold a year from today. The price of gold next year, S_T, is normally distributed with mean 100 and volatility of 20%. The ﬁrm knows that there will be a buyer who is willing to pay the price of 90 per unit, no matter what the value of S_T is. At T = 1, the ﬁrm can choose whether to sell to this buyer or at the market price of S_T.

Firm cash ﬂows are taxed at a ﬂat rate of t = 30%. The risk-free rate is R_F = 5% and is compounded annually. Use two decimal places for your answers.

1) What is the present value of the cash ﬂows of the hedged unlevered ﬁrm after taxes?

2) If the hedged ﬁrm above issues the maximum amount of safe debt D to take advantage of the fact that the interest payments are tax deductible, what is the total present value of the hedged levered ﬁrm’s after-tax cash ﬂows? How does it compare with your answer above, and why?