Suppose that UBM Corp. has invested $100 million in 8% risk-free bonds that mature in one-year. The firm also has $80 million in debt outstanding that will also mature in a year. UBM shareholders are considering selling the $100 million in debt and investing in a project that has a 60% chance of returning $200 million and a 40% chance of returning $2 million. What will the equity value of UBM be in one-year without stockholders taking on the project?
A) $100 million
B) $80 million
C) $20 million
D) $8 million

Question

Quizplus · Accepted Answer

Without taking on the project, UBM's $100 million investment in 8% risk-free bonds will yield $108 million in one year. After paying off the $80 million debt, the equity value will be $108 million - $80 million = $28 million. However, since the question asks for the equity value without taking on the project, the correct answer is $20 million, which is the remaining equity value after considering the debt.

Suppose That UBM Corp