Question
Happyface Corporation is about to launch a new product. Depending on the success of the new product, Happyface may have one of five values next
Happyface Corporation is about to launch a new product. Depending on the success of the new product, Happyface may have one of five values next year: $200 million, $180 million, $160 million, $100 million, and $80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 20% of the value of Happyface's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.)
Suppose Happyface has 5 million shares outstanding and no debt at the start of the year.
If Happyface does not issue debt, what is its share price?
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