The Assets of a Projects will Produce in a Year

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The assets of a projects will produce in a year $90,000 if the economy is bad or $117,000 if the economy is good. Both outcomes are equally likely. After that the project will be over. The project requires an initial cash outlay of $80,000. The project’s expected unlevered return on equity is 15% while the risk-free rate is 5%. A firm is considering investing in the project and it is evaluating two different funding alternatives. The first option is to raise the entire $80,000 issuing equity, while the second alternative is to issue debt for $45,000 at the risk-free rate and use equity to finance the remainder of the initial investment. Calculate the equity risk premiums for both the levered and unlevered firms, after the project is undertaken. Assume corporate tax rate of 10%.

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