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Finance problem: Project evaluation

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ANNA is planning to form a new firm with initial investment of $8Million, there are two projects available for her to choose. the first project offers a 40% chance of a $12.5 million payoff and a 60% chance of a $6 million payoff. the second project offers a 40% chance of a $20 million payoff and a 60% chance of a $4 payoff.

part A
Anna does not have enough funds to finance the firm by herself. she proposes to issue atraight debt to finance the firm. the lender requires a promised payoff of 7$ million.Being the sole shareholder of the new firm, anna will obtain any remaining payoff of the firm after the debt payoff.
(1) based on your calculations which project is preferred( that is , which will generate the most wealth overall)?
(2) please show the possible payoffs to the lender and to anna in both projects. According o your calculations, which project is preferred bu Anna? which project will the lender ant her to choose?
(3) which project is relatively safe? is Anna's optimal choice rational?
(4) in finance, there are some measures available to define the riskiness of a project. Given the above information , please calculate your measure of the riskiness of the two projects, are the results from you risk measure fo the projects consistent with your payoff calculations?
Part B
suppose anna has another choice of issuing convertible bond.The convertible bond can be converted onto 50% of the value of the firm. show the possible payoffs to the lender in each case(1) and (2).will the lender be indifferent between anna's two choices? Why or Why not?

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Solution Summary

The problem deals with the evaluation of an investment opportunity.

Solution provided by:
Chidi Ngene, M. Sc.
Education
  • B. Sc., University of Nigeria
  • M. Sc., London South Bank University
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