Extra Credit Assignment $3$

Instructions: Please answer the following question and submit your responses in a single PDF file by Sunday $($April $14)$ at $11$:$59$ pm on Canvas. You have the option to take pictures of your handwritten responses and compile them into a single PDF file.

Problem: You are an economist for an industrial firm. The firm is financed by equity and risky senior debt. The firm is considering the following risk$-$free project. The investment outlay required for this project is $$100$ million, and the project will return $$120$ million for sure in a year. The risk$-$free rate is $10\%.$ The project can only be financed using junior bonds. The proceeds from the bonds issue are $$100$ million, and the face value of the bonds is $$130$ million, to be paid in one year. After considering this project you decide that it has a positive NPV$,$ and recommend to your manager that the firm will undertake it$.$ Your manager decides to fire you since you foolishly recommended a project that yields $20\%$ while the cost of capital for this investment is $30\%.$ What is going on here?