ABC Corp., which currently has no assets, is considering two projects that each cost $100.

Project A pays off $120 next year in the good state of the economy and $90 in the bad state of the economy. Project B pays off $140 next year in the good state of the economy and $60 in the bad state of the economy. If the two states are equally likely, there are no taxes or direct bankruptcy costs, the risk-free rate of interest is zero, and investors are all risk neutral, which project would equity holders prefer if the firm is 100 percent equity financed? Which project would equity holders prefer if the firm has an $85 bond obligation due next year?

AppendixLO1