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Question - AstraFiz has just completed an expansion of its vaccine factory that was funded with $130 million debt. The factory is expected to generate cash flows of $35 million in the event of a recession (20% probability) and $130 million if economic conditions are favorable (80% probability). The company has an investment opportunity that will require an additional $95 million investment and generate cash flows of $85 million in the event of a recession (20% probability) and $110 million if economic conditions are favorable (80% probability).
Required -
-What is the NPV of the new project assuming all discount rates are 0 (that is, for simplicity, ignore discounting and risk)?
-Suppose the original debt is a senior obligation that does not allow the firm to issue additional debt at the same or higher priority. Will investors be willing to provide new capital to fund the project? (Hint: Calculate the payoffs to the new investors in each outcome, and then the expected payoff to the new investors.)
-Explain briefly (without calculations) why the firm would have a higher value if they had funded the initial factory expansion with equity instead of debt.
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