A firm is worth $50 or $180 with equal probability and is financed with debt that has a face value of $60. It is considering a new project that is equally likely to be worth -$50 or +$40. The cost of capital is 12% for all securities.
-Refer to the information above. What will the bondholder's require as a return on their investment if they fear expropriation?

Question

Quizplus · Accepted Answer

The bondholders will require a return of 36.9% to compensate them for the risk of expropriation. This is because the project has a negative NPV of -$10, and the bondholders will lose their entire investment if the project is expropriated.

A Firm Is Worth $50 or $180 with Equal Probability