You are an entrepreneur starting a technology fir·lf your research 1s successful

Question

You are an entrepreneur starting a technology fir·lf your research 1s successful the echno ogy can be sold for $31 lion. I your researchi unsuccessful, it will be worth nothing. To fund your research, you need o raise $2.5 million. Investors are willing to provide you with 2.5 million n initial capital in exchange or 25% of the unlevered equity in the firm a. What is the total market value of the firm without leverage? b. Suppose you borrow S0.4 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $2.1 million you need? c. What is the value of your share of the firm's equity in cases (a) and (b)? a. What is the total market value of the firm without leverage? The market value without leverage is S million. (Round to one docimal place.)

Explanation / Answer

a. Computation of total market value of the firm without leverage:
Market value = $2.5million * 100%/ 25% = $10million

Since, 100% of unlevered capital = 100% of equity.

b. Here, as per above calculation, market value = $10million
$0.4million debt means (10-0.4)= $9.6million is the total value of equity
Therefore, 21.88% (i.e., 2.1million / 9.6million *100) of equity must be sold to raise $2.1million

c. Computation of value of share:
in case (a) $10million * 25% = $2.5million
in case (b)$9.6million * (1-21.88%) = $7.5million

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