Q 19.36. (Advanced) A firm has $100 in cash and debt of $80. Assume that the...

Q 19.36. (Advanced) A firm has $100 in cash and debt of $80. Assume that the time value of money is zero. A novel project comes along that costs $60 and that will either deliver $0 or x with equal probabilities. xh is the value at which this project would have a positive NPV. xl is the value above which share holders would want the firm to accept the project.

Divide the possible regions into those below xl, those between xl and xh, and those above xh. More specifically, pick xl – $10, (xl + xh)/2, and xh + 10 as your returns in the good state. In these three cases:

a) If the debt can convert into 80% of the postconversion equity, what would the debt and equity be worth? Would existing equity want to take the project?

b) If the debt can convert into 0% of the postconversion equity (i.e., if it is not convertible), what would the debt and equity be worth? Would existing equity want to take the project?

c) If the debt can convert into 40% of the postconversion equity, what would the debt and equity be worth? Would existing equity want to take the project?

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