Consider the case of Ajax Manufacturing which just completed an R&D project on widgets that required a $70 million bond obligation. The R&D effort resulted in an investment opportunity that will cost $75 million and generate cash flows of $85 million in the event of a recession ( prob. 20%) and $150 million if economic conditions are favorable ( prob. 80%). What is the NPV of the project assuming no taxes, no direct bankruptcy costs, risk neutrality, and a risk-free interest rate of zero? Can the firm fund the project if the original debt is a senior obligation that doesn’t allow the firm to issue additional debt?
