You are the owner of a company with $110m of debt maturing at the end of the year. The company generates at the end of the year a cash flow equal to either $130m or $70m with equal probability. There are no subsequent cash flows. Assume risk neutrality and no time value of money.

a) What are the current market values of debt & equity?

b) Assume that you have an opportunity to invest another $25m that yields with certainty another $30m a the end of the year. What are the market values of debt and equity after the investment? As the owner, would you take this investment opportunity if you had to fund the investment out of your pocket. Explain.

c) If you were instead to issue equity to finance this investment opportunity, what fraction of equity would you have to offer to the new investors? Would you issue equity and invest in the new investment opportunity? Explain.

d) If you were to issue debt ha is more senior than the current debt to finance this investment opportunity, what would the face value of the new debt be? Would you issue the new debt and invest in the new investment opportunity? Explain.