Petron Corporations management team is meeting to decide on a new corporate strategy. There are four options,

Question:

Petron Corporation€™s management team is meeting to decide on a new corporate strategy. There are four options, each with a different probability of success and total firm value in the event of success, as shown below:

Assume that for each strategy, firm value is zero in the event of failure.
a. Which strategy has the highest expected payoff?
b. Suppose Petron€™s management team will choose the strategy that leads to the highest expected value of Petron€™s equity. Which strategy will management choose if Petron currently has?
i. No debt?
ii. Debt with a face value of $20 million?
iii. Debt with a face value of $40 million?
c. What agency cost of debt is illustrated in your answer to part(b)?

Cost Of Debt
The cost of debt is the effective interest rate a company pays on its debts. It’s the cost of debt, such as bonds and loans, among others. The cost of debt often refers to before-tax cost of debt, which is the company's cost of debt before taking... Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the...