What face value must the debt holders be promised which, Financial Management

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What face value must the debt holders be promised which

• Example

• An entrepreneur has two mutually exclusive $50 million investment opportunities, R and S, which it plans to fund with debt

• Project S pays $60 million with certainty

• Project R pays $20 million when the economy is poor and $90 million when the economy is good

• Assume that each state has a ½ (risk-neutral) probability of occurring, and the risk-free rate is 0%

a. What face value must the debt holders be promised?

b. Which project will the entrepreneur select?

c. What does the entrepreneur gain?

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