Use the Information for the Question(s)below

question 111

Multiple Choice

Use the information for the question(s) below.
Monsters Incorporated (MI) is ready to launch a new product.Depending upon the success of this product,MI will have a value of either $100 million,$150 million,or $191 million,with each outcome being equally likely.The cash flows are unrelated to the state of the economy (i.e.risk from the project is diversifiable) so that the project has a beta of 0 and a cost of capital equal to the risk-free rate,which is currently 5%.Assume that the capital markets are perfect.
-Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year.The initial value of MI's debt is closest to:

• A)$110 million.
• B)$105 million.
• C)$125 million.
• D)$111 million.

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Definitions:

Loan Payment

A payment made by a borrower to a lender that may include both the principal and interest.

Effective Annual Rate

The interest rate on a loan or financial product restated from the nominal rate as an annual rate, including any compounding that occurs during the year.

APR

Annual Percentage Rate, a measure that reflects the annualized cost of borrowing including interest and other fees, making it easier to compare different financial products.

Rate of Compounding

The frequency with which interest is added to the principal balance of an investment, which can significantly affect the total interest earned or paid.