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W8 Chapter 14 Problems

W8 Chapter 14 Problems - Please complete problems 2 4 14...

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Please complete problems 2, 4 & 14 for chapter 14. 1. You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $30 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $2 million. Investors are willing to provide you with $2 million in initial capital in exchange for 50% of the unlevered equity in the firm. a) What is the total market value of the firm without leverage? Total value of equity:2*$2m=$4m b) Suppose you borrow $1 million. According to MM, what fraction of the firm’s equity will you need to sell to raise the additional $1 million you need? MM says total value of firm is still $4 million. $1 million of debt implies total value of equity is $3 million. Therefore, 33% of equity must be sold to raise $1 million. c) What is the value of your share of the firm’s equity in cases (a) and (b)? In (a), 50% × $4m = $2m. In (b), 2/3 × $3m = $2m. Thus, in a perfect market the choice of capital structure does not affect the value to the entrepreneur.
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