16. Farah's Fashions (FF) will be worth $100 million or $120 million with equal probability in...

 

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16. Farah's Fashions (FF) will be worth $100 million or $120 million with equal probability in one year. FF is highly leveraged and has bonds outstanding promising to pay $90 million next year. FF is considering a risky project that will payoff $50 million or -$65 million with equal probability. Would FF's shareholders want you to engage in the risky project? What is the expected payoff to FF's existing shareholders? How would your answers change if the bondholders could convert the bond to 80% of FF's equity? 16. Farah's Fashions (FF) will be worth $100 million or $120 million with equal probability in one year. FF is highly leveraged and has bonds outstanding promising to pay $90 million next year. FF is considering a risky project that will payoff $50 million or -$65 million with equal probability. Would FF's shareholders want you to engage in the risky project? What is the expected payoff to FF's existing shareholders? How would your answers change if the bondholders could convert the bond to 80% of FF's equity?

Answer rating: 100% (QA)

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