Problem $4(20\%)$

Assume the risk$-$free rate is $5\%,$ the new product is equally likely to succeed or to fail, and the

project has a beta of $0($i$.$e$.,$ this risk is diversifiable$)$ and the cost of capital is the risk$-$free rate.

Without financial distress, the value of debt and equity $($$ million$)$ is:

The value of debt and equity $($ $ million$)$ when financial distress is costly is:

Suppose that at the beginning of this year, the firm has $10$ million shares outstanding and no

debt. Later, the firm announces plans to issue one$-$year debt with a face value of $$100$ million

and to use the proceeds to repurchase shares.

$,$ Based on the information above, what will the new share price be$?(10\%)$

Who pay for financial distress costs? How much? When? $(10\%)$