Question

Suppose your project is worth $822 with a probability of 0.9 and $492 with a probability of 1-0.9. The appropriate cost of capital is 9.2% for the overall project. If you want to raise $664 today and promise to bond investors a rate of return of $5.4, what's the expected rate of return of this bond?____________________ Please answer both Carry out calculations to at least 4 decimal places. Enter percentages as whole numbers. Example: 3.03% should be entered as 3.03. Do not include commas or dollar signs in numerical answers.

Answer 1

A	B	C	D	E	F	G	H	I
2
3		Bond holders are paid the full amount if project worth is higher than the total debt value,
4		however if the value of the project is lower than the value of the project then the
5		debt value equals the project value.
6
7		Amount of Debt Raised	$664
8		Promised return to debtholders	5.40%
9		Expected Value of Debt after one Year	$699.86	=D7*(1+D8)
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11		Probability	Project Worth	Debt Value	Return to debt holders
12		0.9	$822	$699.86	5.40%	=(E12-$D$7)/$D$7
13		0.1	$492	$492.00	-25.90%	=(E13-$D$7)/$D$7
14
15		Expected return of debtholder	=0.9*5.40%+0.1*-25.90%
16			2.27%	=C12*F12+C13*F13
17
18		Expected return of debtholder	2.27%
19