Option pricing theory can also be used in corporate finance. Consider the following scenario. At time 0, a company needs cash to finance a large project. This company decides to take on some debt (that is, it borrows money from debt creditors) to finance this project. The total value of the company is Co at inception and C at maturity. This value includes all assets that this company holds. Any debt that the company takes on is a claim on the total value of the company. That is, if this company does not pay back its debt at time T, then it will declare bankruptcy and the debt creditors can confiscate all of ABS's asset CT. We assume that the amount of debt that the company takes on has a face value of 100 at maturity. Therefore, if C1 > 100, the debt creditors will receive the full face value 100; if C 0 > d and u+d > 0. (a) Plot a binomial tree that corresponds to the pricing of the convertible debt in the two-period model. (b) Use the Snell envelop to determine the pricing of the convertible debt in this model. (Hint: At time 1, the holder will only exercise when the risk neutral value of conversion is larger than the value of keeping the debt.) Option pricing theory can also be used in corporate finance. Consider the following scenario. At time 0, a company needs cash to finance a large project. This company decides to take on some debt (that is, it borrows money from debt creditors) to finance this project. The total value of the company is Co at inception and C at maturity. This value includes all assets that this company holds. Any debt that the company takes on is a claim on the total value of the company. That is, if this company does not pay back its debt at time T, then it will declare bankruptcy and the debt creditors can confiscate all of ABS's asset CT. We assume that the amount of debt that the company takes on has a face value of 100 at maturity. Therefore, if C1 > 100, the debt creditors will receive the full face value 100; if C 0 > d and u+d > 0. (a) Plot a binomial tree that corresponds to the pricing of the convertible debt in the two-period model. (b) Use the Snell envelop to determine the pricing of the convertible debt in this model. (Hint: At time 1, the holder will only exercise when the risk neutral value of conversion is larger than the value of keeping the debt.)