Problem: You are an economist for an industrial firm. The firm is financed by equity and...

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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? 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?