Reference no: EM133100770

Question

Everyone is risk neutral and the risk free rate is 0%. Firm A needs to raise $2,000 by issuing a 1- year bond with face value $2,000 and coupon rate c in order to pursue either Safe Project S, or Risky Project R, which would each require an investment of $2,000 at t=0. S will produce $2,500 at t = 1. R will produce either X or 0 at t = 1 with probability 50% for each outcome. The company decides between Sand R after they get the money from bondholders. Bondholders are aware that equity holders will do what is optimal for equity holders.

1. For what value of X would the following be a valid equilibrium solution: the company issues debt with face value 2000 and coupon rate 0% and invests in S.

a. 2,800

b. 3,200

c. 3,500

d. 6,000

e. 7,000

f. None of the above

2. For what value of X could the following be a valid equilibrium solution: the company issues risky debt and invests in R.

a. 2,800

b. 3,200

c. 3500

d.) 6000

e. All of the above

f. None of the above

3. Now assume that X = 9,000, the company has 100 shares outstanding, and the bond is a 1-year Zero coupon bond with face value $2,000 and convertible into N shares at t = 1 after the outcome of the company's project. For which value of N is the following an equilibrium solution: the company issues the bond and selects Project S

a. 5

b. 6

c. 7

d. 8

e. All of the above

f. None of the above