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30 March, 11:13

You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $ 30$30 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $2.02.0 million. Investors are willing to provide you with $2.02.0 million in initial capital in exchange for 50 %50% of the unlevered equity in the firm. a. What is the total market value of the firm without leverage? b. Suppose you borrow $1.01.0 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $1.01.0 million you need? c. What is the value of your share of the firm's equity in cases (a ) and (b ) ? a. What is the total market value of the firm without leverage?

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  1. 30 March, 12:41
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    a. What is the total market value of the firm without leverage?

    = $2 million / 50% = $4 million

    b. Suppose you borrow $1.0 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $1.0 million you need?

    = 33.33%

    c. What is the value of your share of the firm's equity in cases (a ) and (b ) ?

    a) = $4 x 50% = $2 million b) = $2 million

    Explanation:

    if successful price = $30 million

    if unsuccessful price = $0

    investment required = $2 million

    in exchange of 50% of the firm

    if you borrow $1 million, you will have to give up 33.33% of the company in exchange for the other $1 million needed

    = $1 / ($4 - $1) = $1 / $3 = 33%

    according to Modigliani and Miller (MM), the value of a firm is determined by its profit.
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