The All-Mine Corporation is deciding whether to invest in a new one-year project. The project would have to be financed by equity, the cost is $2,000, and the return will be a guaranteed $2,500 in one year. The discount rate for both bonds and stock is 15 percent and the tax rate is zero. The predicted cash flows excluding this new project are $4,500 in a good economy, $3,000 in an average economy, and $1,000 in a poor economy. Each economic outcome is equally likely to occur and the promised debt repayment is $3,000. Should the company take the project

Question

Sasha

Business

18 September, 11:22

The All-Mine Corporation is deciding whether to invest in a new one-year project. The project would have to be financed by equity, the cost is $2,000, and the return will be a guaranteed $2,500 in one year. The discount rate for both bonds and stock is 15 percent and the tax rate is zero. The predicted cash flows excluding this new project are $4,500 in a good economy, $3,000 in an average economy, and $1,000 in a poor economy. Each economic outcome is equally likely to occur and the promised debt repayment is $3,000. Should the company take the project

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Answers (1)

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Jessie Campbell · Answer 1

A. NPV of the project

NPV = - 2000 + 2500 / (1.15) = $173.91

B. Value of the firm and its debt and equity components before and after the project addition.

Determine expected cash flows before the project.

($3,000 + $3,000 + $1,000) / 3) / 1.15 = $2,333.33/1.15 = $2,028.99

($1,500 + $0 + $0) / 3) / 1.15 = $500/1.15=$434.78

Determine value with project.

($3,000 + $3,000 + $3,000) / 3) / 1.15 = $3,000/1.15 = $2,608.70

($4,000 + $2,500 + $500) / 3) / 1.15 = $2,333.33/1.15=$2,028.99

C. The company should not take the project because the NPV does not go to equity but to bond holders.