Problem:

Gator Software has just completed an R&D project that required borrowing senior debt from a bank. The bank has been promised a repayment of $140 million. This R&D effort has resulted in an investment opportunity that will cost an additional $200 million and will result in a cash flow of $180 million with probability .5 and $420 million with probability .5. The firm has no cash on hand and no other assets except for this investment opportunity. Assume risk-neutrality, a zero interest rate, no direct bankruptcy costs, and no taxes.

Task:

Question 1: Could the firm fund the investment opportunity with an equity issue?

Question 2: Could the firm fund the investment opportunity with an issue of junior debt?

Question 3: Could the firm fund the investment opportunity with a sale of senior debt to a new investor with a promised repayment of $240 (assuming that this is allowed in the existing bank loan agreement)?

Question 4: Could the firm fund the investment opportunity with an issue of new senior debt with a promised repayment of greater than $240 (assuming that this is allowed in the bank loan agreement). What would you predict for the minimum face value (i.e., promised repayment) of the new debt that would be necessary to raise funds for the investment opportunity? Explain in detail and provide all calculation.