Ms. Blavatsky is proposing to form a new start-up company with initial assets of $10 million. She can invest this money in one of two projects. Each project has the same expected payoff, but one has more risk than the other. The relatively safe project offers a 40 percent chance of a $12.5 million payoff and a 60 percent chance of an $8 million payoff. The risky project offers a 40 percent chance of a $20 million payoffand a 60 percent chance of a $5 million payoff. Ms. Blavatskys financial advisorproposed two alternative financing options.

Financing Option A: Raise $10 million through an issue of straight debt with a promised payoff, to the lenders, of $7 million. Ms. Blavatsky will receive any remaining payoff.

Financing Option B: Raise $10 million through an issue of a convertible bond with a promised payoff, to the lenders, of $7 million and the right for bondholders to convert their investments into 50 percent share of the value of the company. Ms. Blavatsky will receive any remaining payoff.

a) Calculate the possible payoffs and the expected payoffs to the lender from the two projects under Financing Option A (a straight-bond financing).

b) Calculate the possible payoffs and the expected payoffs to Ms. Blavatsky from the two projects under Financing Option A (a straight-bond financing).

c) Calculate the possible payoffs and the expected payoffs to the lender from the two projects under Financing Option B (a convertible-bond financing).

d) Calculate the possible payoffs and the expected payoffs to Ms. Blavatsky from the two projects under Financing Option B (a convertible-bond financing).

e) Compare the expected payoffs to the lender and to Ms. Blavatsky. Which project is Ms. Blavatsky likely to choose? Which project will the lender want her to choose? Discuss the benefits of using convertible bond financing in this case.