Gladstone corporation is about to launch a new product. depending on the success of the new product, the company may have one of four values next year: $150 million, $135 million, $95 million, and $80 million. these outcomes are all equally likely, and this risk is idiosyncratic (diversifiable). assume the risk-free interest rate is 5% and that we're in perfect capital markets.

Question

Emerson Griffin

Business

30 August, 02:13

Gladstone corporation is about to launch a new product. depending on the success of the new product, the company may have one of four values next year: $150 million, $135 million, $95 million, and $80 million. these outcomes are all equally likely, and this risk is idiosyncratic (diversifiable). assume the risk-free interest rate is 5% and that we're in perfect capital markets.

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Izabella Garrett · Answer 1

The value of the equity of Gladstone is the mean of the values of all possible outcomes. In specific, the average value at the end of the year is:

(150+135+95+80) / 4=115 million dollars.

We also need to account for the risk-free interest which depreciates our investment; If the rate is x%, we need to divide with 1+x/100 115/1.05=109.5 Million dollars. This is the value of the equity.