Question :01

The Food Republic Co. plans to launch a new branch in Singapore. But they are debating the location of the new branch either in the traditional Business district (project B), or in the Casino area near Marina Bay (Project C). The new branch, regardless of the location, will cost $10 million a year to set up and maintain, used for space rental, furniture, decoration, etc. Project B, locating the new branch in the business district, is expected to yield $11 or $12 million in the next year with equal chance. Because of the high uncertainty of the tourists visiting the casino, the cash flows generated by Project C in the next year is very uncertain $14.2 million with 1/3 chance and $6 million otherwise.

a) Suppose the discount rate is zero. You are the CEO of Food Republic and plan to raise the $10 million investment capital through equity financing. What is your decision on the projects? Why?

b) Can your firm obtain $10 million in debt financing by issuing a zero-coupon bond with a face value of $10 million? Which project will you take if such a bond is issued and what is the expected payoff to Food Republic? Assume debt holders cash flow rights are attached on the project.

c) Suppose the risk-free discount rate is 10%, what would the bonds face value for lenders to receive a fair return? How this would affect Food Republics investment decision? What would be the implication to its debt financing?