The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year.

Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state.

Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not?

Alternatively, Lando can issue new equity of $30 million to finance the project.

(d) What proportion of its equity must Lando give to the new equityholders? Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year. Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state. Investors are all risk neutral and the risk free rate is zero. (a) What are the expected values of the firm's equity and debt without the new project? Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt. (b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy? (c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not? Alternatively, Lando can issue new equity of $30 million to finance the project. (d) What proportion of its equity must Lando give to the new equityholders? Will Lando’s managers choose to accept the project now? Why/why not? (e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year. Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state. Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not? Alternatively, Lando can issue new equity of $30 million to finance the project.

(d) What proportion of its equity must Lando give to the new equityholders? Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)

The below is for a hypothetical study demonstrating the application of the concepts for superiority and non-inferiority testing.

A study investigated a new agent for the treatment of arthritis. Participants were randomized to receive either the current widely used (and effective) treatment or to the new experimental treatment. After 3 weeks they recorded if, based on a clinical assessment, there were improvements in symptoms (recorded as yes/no). Because of the potential large impact of age the investigators used a multiple regression model to test for differences adjusting for age. (Technically since the outcome is binary they used what is called a logistic regression model, but the analytic approach is the same.) Investigators want to test if the new treatment is non-inferior to the current treatment. Treatment is coded as 0=usual treatment and 1=new treatment so that a positive coefficient represents greater improvement with the new treatment. The study was done on a large sample and you may use the normal distribution for testing coefficients. Prior to testing the investigators selected (+/-) 0.40 for the non-inferiority parameter (delta).

A. Based on the above table, what is the 95% confidence interval for the coefficient for the treatment effect (beta1)?

B. Is the p-value for testing the superiority of the new treatment greater than or less than 0.05?

C. What can you conclude from the above analyses concerning the superiority of the new treatment?

D. Using the above non-inferiority parameter, what can the investigators conclude about the non-inferiority of the new treatment? Justify your response.

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year.

Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state. Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not?

Alternatively, Lando can issue new equity of $30 million to finance the project.

(d)What proportion of its equity must Lando give to the new equityholders? Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question.

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year.

Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state.

Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not?

Alternatively, Lando can issue new equity of $30 million to finance the project.

(d)What proportion of its equity must Lando give to the new equityholders?

Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)

The firm Kito expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has a debt with face value $65 million due in one year. Kito is considering a new project that would require an investment of $30 million today and would result in cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state. Investors are all risk-neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Kito can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Kito promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Kito's equity? Will Kito's managers choose to accept the project? Why/why not?

Alternatively, Kito can issue new equity of $30 million to finance the project.

(d) What proportion of its equity must Kito give to the new equity holders? Will Kito's managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely.
The firm also has debt with face value $65 million due in one year.

Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state.

Investors are all risk neutral and the risk free rate is zero.
(a) What are the expected values of the firm's equity and debt without the new

project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not?

Alternatively, Lando can issue new equity of $30 million to finance the project.

(d) What proportion of its equity must Lando give to the new equityholders? Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to answers to the previous parts of the question.

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year.

Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state.

Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debtholders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not?

Alternatively, Lando can issue new equity of $30 million to finance the project.

(d)What proportion of its equity must Lando give to the new equityholders? Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)

(Total = 25 marks)

The firm Lando expects cash flows in one year’s time of $90 million if the economy is in a good state or $40 million if it is in a bad state. Both states are equally likely. The firm also has debt with face value $65 million due in one year. Lando is considering a new project that would require an investment of $30 million today and would result in a cash flow in one year’s time of $47 million in the good state of the economy or $32 million in the bad state.

Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt without the new project?

Lando can finance the project by issuing new debt of $30 million. If the firm goes bankrupt the new debt will have a lower priority for repayment than the firm’s existing debt.

(b) If the new project is accepted, what will be the value of the firm’s cash flow in each state after paying the original debtholders? What payment must Lando promise to the new debt holders in the good state of the economy?

(c) What will be the expected value of Lando’s equity? Will Lando’s managers choose to accept the project? Why/why not?

Alternatively, Lando can issue new equity of $30 million to finance the project.

(d)What proportion of its equity must Lando give to the new equity holders?
Will Lando’s managers choose to accept the project now? Why/why not?

(e) Briefly discuss the agency problem of debt overhang with reference to your answers to the previous parts of the question. (120 words)