Monsters Incorporated (MI) is ready to launch a new product. Depending upon the
ID: 2669609 • 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.(d) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:
(1) $133 million
(2) $140 million
(3) $147 million
(4) $125 million
(e) Assuming that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs, the initial value of MI’s equity without leverage is closest to:
(1) $150 million
(2) $147 million
(3) $140 million
(4) $133 million
(f) Assume that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:
(1) $140 million
(2) $100 million
(3) $125 million
(4) $134 million
Explanation / Answer
d) 125*.05 + 125 = 131.25 => 133 e) 191 - (191*.2) = 152.8 => 150 f) 125 - (125*.2) = 100