Everyone believes that next year the value of your firm will be at least $80 but not more than $120. That is, in the most pessimistic scenario, the value will be $80, and in the most optimistic scenario, the value will be $120. Your firm is financed with both debt and equity. The debt is zero-coupon, has a face value of $100, and will mature next year (t=1). The yield to maturity on the debt is currently 12%, and the risk-free rate is 6%.

Your firm is considering raising $10 to invest in a safe project that will yield a certain cash flow of $20 next year. If the firm is able to raise the money in a perfectly competitive market (and the new equity holders break even on average), by how much will the market value of the existing equity increase?

(Please express your answer in dollars with one digit after the decimal point.)

Answer rating: 100% (QA)

Cost of new project 10 profit PV of profit ... View the full answer