Pricing the bond (cont.):
We've assumed that the bond market is competitive. Given
that assumption, bondholders will only pay the expected value of the bond.
What happens if bondholders pay 70?
|
Project |
0 |
1 |
2 |
NPV |
|
A |
-50 |
100 |
50 |
100 |
|
B |
-75 |
100 |
25 |
|
|
Bond |
70 |
-20 |
-100 |
|
|
Div(A+B) |
||||
|
Div(A) |
What will the shareholders do?
What rate of return will bondholders realize?
What will be the value of the firm?
How does the firm in this case compare to the firm value when the firm was all equity financed?