Answer to Question #272650 in Financial Math for cliffe

Question

Question three (9 marks)

ABC Company is being formed to make a 1 year investment in producing and marketing presidential campaign badges. The firm requires an investment of Sh 10,000,000 of which Sh 7,500,000 will be obtained by selling debt with a 10% interest rate and the other Sh 2,500,000 will be raised by selling common shares. All cash distribution to debt holders and shareholders will be made at the end of the one year. After this year is over the value of the firm will depend primarily on which candidates make it through the primary elections. The estimated probability of distribution of the firm is:

Probability Value `000'

0.7 20,000

0.2 5,000

0.1 0

Consider the shareholders value under the three states of nature and under the expected value.

Answer 1

under the expected value:

$E(X)=0.7\cdot20000000+0.2\cdot 5000000=15000000$