Reference no: EM132715761

Question - Company is about to launch a new product. Depending on the success of the new product, Company may have one off our values next year: $150 million, $135 million, $95 million, or $80 million. These outcomes are all equally likely, and the risk of the project is diversifiable.

Suppose the risk-free interest rate is 5% and that, in the event of default, 25% of the value of Company's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.)

1) Assume that Company is all equity financed. What is the value of equity? Now suppose Company has zero-coupon debt with a $100 million face value due next year.

2) What is the initial value of Company's debt?

3) What is the yield-to-maturity of the debt?

4) What is the initial value of Company's levered equity? What is Company's total value with leverage?

Suppose Company has 10 million shares outstanding and no debt at the start of the year.

5) lf Company does not issue debt, what is its share price?

6) lf Company issues debt of$ 100 million due next year and uses the proceeds to repurchase shares, what will its share price be? Why does your answer differ from that in part (5)?