Use the Information for the Question(s)below

question 42

Multiple Choice

Use the information for the question(s) below.
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%.
-Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk-free rate and issues new equity to cover the remainder.In this situation,the cash flow that equity holders will receive in one year in a weak economy is closest to:

• A)$90,000.
• B)$0.
• C)$50,000.
• D)$48,000.

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Definitions:

Saving Benefits

The advantages gained from setting aside income or resources for future use, including accruing interest, financial security, and preparedness for emergencies.

Substitution Effect

This refers to the economic theory that as prices rise or fall, consumers will replace more expensive items with less costly alternatives.

Income Effect

Refers to the change in an individual's or economy's income and how that change will affect the quantity demanded of a good or service.

Tax Rate

The rate at which taxes are applied to an individual or a corporation’s income.