2) Shareholder - Debtholder Problem: Assume that a firm is worth $1,000. Debtholders hold claims to the first $900, and equity has claim to the remainder. Equity holders have an opportunity to invest in a project that costs $500 today, and with 40% probability, the project will be worth $1,000 tomorrow. With 60% probability, the project will be worthless tomorrow. Again, for simplicity, assume that there is no time value of money here. Also, for simplicity, assume that if the value of the project equals zero, then the project will not be undertaken.

a) What is the NPV of this project, and should it be accepted or rejected based on the NPV? -$100, accept -$100, reject $140, accept $140, reject

b) What is the value of this project to shareholders, and would they rationally accept or reject? -$100, accept -$100, reject $140, accept $140, reject