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 stockholders 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 is the expected value of the bonds to the lenders if the stockholders sell the debt?
A) $100 million
B) $88.8 million
C) $48.8 million
D) None of the above

Question

Quizplus · Accepted Answer

The expected value of the project is (0.6 * $200 million) + (0.4 * $2 million) = $120.8 million. After paying off the $80 million debt, the expected value to the lenders is $120.8 million - $80 million = $40.8 million. However, since the bonds are risk-free, the lenders will receive the full $80 million, so the expected value of the bonds to the lenders is $48.8 million.

Suppose That UBM Corp