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Question 5 Suppose you are the owner of company Supernova ple. The company has debt maturing next year with face value 100m. The company will be generating next year when the debt is due a cash flow equal to either 120m or 60m with equal probability. There is no cash at hand and no subsequent expected cash-flow. Assume risk neutrality and no discounting, Required: (a) Based on the information, what are the market values of debt and equity? (6 marks) (b) Now suppose you have an opportunity to invest another 20m that can yield an additional 25m with certainty on top of the currently projected outcomes. What is the NPV of this additional investment? What is the market value of debt and equity after the investment? If you, as the owner, have to fund the investment out of pocket, should you invest? Explain. (6 marks) (c) If instead you were to issue new debt that was more senior than the current debt to finance the new investment, what would be its fair face value? What is the market value of the original debt and equity? Should you issue this new debt and invest? (4 marks) (d) How would your answers to parts b) and c) change if the face value of debt was equal to 170m? Question 5 Suppose you are the owner of company Supernova ple. The company has debt maturing next year with face value 100m. The company will be generating next year when the debt is due a cash flow equal to either 120m or 60m with equal probability. There is no cash at hand and no subsequent expected cash-flow. Assume risk neutrality and no discounting, Required: (a) Based on the information, what are the market values of debt and equity? (6 marks) (b) Now suppose you have an opportunity to invest another 20m that can yield an additional 25m with certainty on top of the currently projected outcomes. What is the NPV of this additional investment? What is the market value of debt and equity after the investment? If you, as the owner, have to fund the investment out of pocket, should you invest? Explain. (6 marks) (c) If instead you were to issue new debt that was more senior than the current debt to finance the new investment, what would be its fair face value? What is the market value of the original debt and equity? Should you issue this new debt and invest? (4 marks) (d) How would your answers to parts b) and c) change if the face value of debt was equal to 170m

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