Question

You are an entrepreneur starting a biotechnology firm. If your research is​ successful, the technology can be sold for $ 30$30 million. If your research is​ unsuccessful, it will be worth nothing. To fund your​ research, you need to raise ​$2.02.0 million. Investors are willing to provide you with ​$2.02.0 million in initial capital in exchange for 50 %50% of the unlevered equity in the firm. a. What is the total market value of the firm without​ leverage? b. Suppose you borrow ​$1.01.0 million. According to​ MM, what fraction of the​ firm's equity will you need to sell to raise the additional ​$1.01.0 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?

Answer 1

Answer:

a. What is the total market value of the firm without​ leverage?

• = $2 million / 50% = $4 million

b. Suppose you borrow ​$1.0 million. According to​ MM, what fraction of the​ firm's equity will you need to sell to raise the additional ​$1.0 million you​ need?

• = 33.33%

c. What is the value of your share of the​ firm's equity in cases ​(a​) and ​(b​)?

• a) = $4 x 50% = $2 million
• b) = $2 million

Explanation:

if successful price = $30 million

if unsuccessful price = $0

investment required = $2 million

in exchange of 50% of the firm

if you borrow $1 million, you will have to give up 33.33% of the company in exchange for the other $1 million needed

= $1 / ($4 - $1) = $1 / $3 = 33%

according to Modigliani and Miller (MM), the value of a firm is determined by its profit.