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Problem: Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000 and the project's cost of capital is 15%. The risk-free interest rate is 5%.
Required:
Question 1: What is the project's NPV?
Question 2: Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. What is the market value of unlevered equity in this case?
Question 3: Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate. What is the value of the firm's levered equity in this case?
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