Consider a firm with current asset value of $200m. The firm has debt outstanding, which

they issued 5 years ago, with zero-coupon and face value F = 250, which matures in 1 year.

T-bonds are currently yielding 8%, and the firms assets have a 25% volatility.

(a) What would you expect the firms debt to trade at? What is its current credit spread?

(b) The firm can invest $12m in order to get future cash flows which, in PV terms, are worth

$20m. Management is considering issuing some equity in order to finance this project,

since the firm would have a hard time tapping bond markets. In particular, management

will go to the current shareholders and ask them to put down the $12m in order to undertake this positive NPV project. Given you have hard numbers on the fact that the

project has a positive NPV, you are confident the shareholders will agree. Will they?

Why (or why not)?

(c) Redo the previous two parts assuming the assets in place are worth $300m, instead of

$200m.

(d) Say something interesting (related to your previous answers).