What if the firm is not all equity?


Consider the same firm, but with debt in its capital structure obligating it to make payments as shown below.

Project

0

1

2

NPV

A

-50

100

50

100

B

-75

100

25

Bond

?

-20

-100

Also, assume the following:

  1. interest rates, taxes, and flotation costs are zero
  2. there is a covenant in the bond precluding the firm from issuing more debt during the life of the bond
  3. shareholders may receive dividends (in any given year) only after the claims of the bondholders have been satisfied
  4. the firm must either pay bondholders, or surrender the firm's assets to the bondholders
  5. the bond market is competitive.

What is the price of the bond?