XY Incorporated is ready to launch a new product. Depending upon the success of this product, XY will have a value of either $100 million or $200 million, with probabilities of 60% and 40%, respectively. The cash flows are unrelated to the state of the economy (i.e. risk from the project is diversifiable) so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume perfect capital markets.

1.Calculate the initial value of XY's equity without leverage.

2.Suppose that XY has zero-coupon debt with $125 million due next year. Calculate the current value of XY's debt.