Suppose that, in the previous problem, Childs is considering two mutually exclusive investments. Project A has an NPV of $135, and Project B has an NPV of $215. As a result of taking Project A, the variance of the fi rm’s return on assets will increase to .39. If Project B is taken, the variance will fall to .22.

a. What is the value of the fi rm’s debt and equity if Project A is undertaken? If Project B is undertaken?

b. Which project would the shareholders prefer? Can you reconcile your answer with the NPV rule?

c. Suppose the shareholders and bondholders are in fact the same group of investors. Would this affect the answer to part (b)?

d. What does this problem suggest to you about shareholder incentives?

Round computed values for d₁ and d₂ to the nearest values in Table 25A.1 for determining N(d1) and N(d2), respectively.