Use the Information for the Question(s)below

question 19

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 cost of capital for the firm's levered equity is closest to:

• A)23%.
• B)25%.
• C)15%.
• D)18%.

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Definitions:

Maximum Loss

The greatest potential loss one could incur in an investment or trading position.

2-For-1 Split

A stock split where for each share owned, a shareholder receives an additional share, effectively doubling the number of shares.

Premium

The amount paid for an option or insurance policy above its intrinsic value or the amount that an asset's selling price is above its face value.

Gross Profit

The difference between sales revenue and the cost of goods sold before deducting overhead, payroll, taxation, and interest payments.