Consider the setting of Problem 21, and suppose Petron Corp. has debt with a face value of $40 million outstanding. For simplicity assume all risk is idiosyncratic, the risk-free interest rate is zero, and there are no taxes. What is the expected value of equity, assuming Petron will choose the strategy that maxi- mizes the value of its equity? What is the total expected value of the firm?

Expected Value of Equity| Business & Finance homework help

Petron Corp. can earn its potential profits by selling oil if all three wells are successful. The company would make $100 million if all three oil wells were successful (assuming that each one generates $30 millions). Petron’s profits will come from all 3 successful wells if they are 33% or 1/3.

This information can be used to calculate the expected value of equity:
Expected Value = (1/3)($100 million) – ($40 million) = $26.67 million
If all three wells succeed, then the total revenues are $100 million minus $40 million in debt payments. This leaves them an excess of cash of $60million that they can distribute as dividends.

The total expected value of firm’s equity plus debt is simply the sum of both components: Expected Value(Equity + Debt) = 26.67 + 40 = 66.67 million dollars. This figure represents an approximation for Petron’s overall financial position under this scenario given their current levels of debt, potential oil sales revenues and risk profile associated with each individual drill site