A Firm Consists of a Single Project

question 40

Essay

A firm consists of a single project. If the project is very successful, the firm will be
worth $800. If it is less successful, the firm will be worth only $360. There is a 60%
chance that the project will be very successful. The firm has a single, zero-coupon
bond with a face value of $500 and a required return of 8%. The cost of capital for the
overall firm is 12%. What is the cost of capital of the levered equity? What is the
promised rate of return on the debt?

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Definitions:

Bankruptcy Abuse Prevention

Part of the legal measures designed to prevent misuse of bankruptcy laws, including provisions to ensure that filings are genuine and to deter fraudulent or reckless bankruptcy claims.

Chapter 7

A provision of the bankruptcy code in the United States that provides for "liquidation," whereby a debtor's non-exempt assets are sold and the proceeds are used to pay creditors.

Automatic Stay

A self-operating postponement of collection proceedings against a debtor who has filed a petition for bankruptcy.

Collection Proceedings

The legal process initiated by creditors to recover money owed by a debtor.