Hiroko Fashion Corporation (HFC) can pursue either project Dress or project Cosmetic, with possible payoffs at year-end as follows:

Each project costs $6 million at the beginning of the year. Assume there are no taxes, there are no direct bankruptcy costs, all investors are risk neutral, and the risk-free interest rate is zero.

a. Which project should HFC pursue if it is all equity financed? Why?

b. If HFC has a $5 million bond obligation at the end of the year, which project would its equity holders want to pursue? Why?AppendixLO1

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Project Dress Project Cosmetic Bad Economy Good Economy (prob. = 30%) (in $ millions) (prob. = 70%) (in $ millions) $2 7 $9 6