A firm has debt due next year and the amount is 100. It has cash of...

A firm has debt due next year and the amount is 100. It has cash of 10. It has only 1 project to invest. If the project succeeds, it will generate 1000 cash flow next year and 0, otherwise. Probability of success is 5%. Initial cost of project is 10. If the firm does not invest in the project, it will put 10 cash into risk-free asset. Risk-free return is 2%. Discount rate for the project cash flow is 10%.

Suppose manager maximizes equity holder value. Would he invest in this project? (4pt)

What is PV of debt if manager decides to invest in the project? What is PV of debt if manager decides NOT to invest in the project but put 10 cash into risk-free asset? (3pt)

Would debtholders like the firm to invest in the project? (3pt)

What is the minimum success probability above which debtholders like the firm to invest in the project? (3pt)

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Expert Solution

ekkarill92 answered 1 year ago

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