Monsters Incorporated (MI) is ready to launch a new product. Depending upon the
ID: 2669547 • Letter: M
Question
Monsters Incorporated (MI) is ready to launch a new product. Depending upon the success of this product, MI will have a value of $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy and the cost of capital is equal to the risk-free rate, which is currently 5%. Assume that capital markets are perfect.(a) The initial value of MI’s equity without leverage is closest to:
(1) $133 million
(2) $147 million
(3) $140 million
(4) $150 million
(b) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s debt is closest to:
(1) $125 million
(2) $111 million
(3) $100 million
(4) $116 million
(c) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s equity is closest to:
(1) $30 million
(2) $15 million
(3) $29 million
(4) $24 million
Explanation / Answer
Monsters Incorporated (MI) is ready to launch a new product. Depending upon the success of this product, MI will have a value of $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy and the cost of capital is equal to the risk-free rate, which is currently 5%. Assume that capital markets are perfect.
(a) The initial value of MI’s equity without leverage is closest to:
(1) $133 million
(2) $147 million
(3) $140 million
(4) $150 million
(b) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s debt is closest to:
(1) $125 million
(2) $111 million
(3) $100 million
(4) $116 million
(c) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s equity is closest to:
(1) $30 million
(2) $15 million
(3) $29 million
(4) $24 million