Ask Question
19 December, 01:56

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%. Suppose that you borrow $30,000 in financing the project. According to MM proposition II, the firm's equity cost of capital will be closest to:A) 21%B) 15%C) 20%

+4
Answers (1)
  1. 19 December, 04:30
    0
    A) 21%

    Explanation:

    The cost of equity in a geared company is higher than the cost of equity

    in an ungeared company. The cost of equity in a geared company is equal to the cost of equity of an ungeared company plus a financial risk premium.

    Keg=Keu+D/E (Keu-Kd)

    Keg=15%+30,000/50,000 (15%-5%)

    =21%

    So the answer is A) 21%

    Where:

    E = Market value of equity of the geared company = $50,000 (80,000-30,000)

    D = Market value of debt = $30,000

    Keu = Cost of equity of an ungeared company = 15%

    KEG = Cost of equity of a geared company = ?

    KD = Cost of debt=5%
Know the Answer?
Not Sure About the Answer?
Get an answer to your question ✅ “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 ...” in 📙 Business if there is no answer or all answers are wrong, use a search bar and try to find the answer among similar questions.
Search for Other Answers