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The value of HILEV firm at the end of one year can be $50 m or...

The value of HILEV firm at the end of one year can be $50 m or $100 m with equal probability of 0.5. The firm has debt with a face value of $50 m that matures in one year. Assume that investors are risk-neutral and the risk free rate is zero. The CEO of the firm decides to substitute assets of the firm with more risky assets immediately, so that the value of the firm at the end of one year is either $30 m or $120 m with equal probability of 0.5. This asset substitution will lead to

A gain of $10 million for stockholders and a loss of $10 million for bondholders

b. A loss of $10 million for stockholders and a gain of $10 million for bondholders

c. No gain or loss to debtholders or equity holders

d. Both debtholders and equity holders will lose $10 million from the increased risk of the business

* I answered C and it was incorrect

Solutions

Expert Solution

Answer Option (a): A gain of $10 million for stockholders and a loss of $10 million for bondholders.

Explanation:

jeff jeffy answered 4 months ago
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