You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $30 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $2 million. Investors are willing to provide you with $2 million in initial capital in exchange for 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 million. According to M&M, what fraction of the firm’s equity will you need to sell to raise the additional $1 million you need?
c. What is the value of your share of the firm’s equity in cases (a) and (b)?