5. You are evaluating two mutually exclusive one-year investment projects. Each project requires an initial investment of $300, the payoffs are described in the following tables.

Project Probability Payoff (t=+1)

X 0.25 $200

0.50 $400

0.25 $600

Y 0.50 $300

0.50 $500

a. Calculate the expected payoff at t=1 and the NPV of each project. Assume all equity financing and the cost of equity for all-equity firm is 25%. If you are the only stockholder, which project would you choose?

b. If you finance the project with 30% equity (i.e. $90) and 70% debt (i.e. $210), determine the payoffs to stockholders and bondholders. The debt will be repaid in one year with the interest. Assume the cost of equity for this firm = the cost of debt for this firm = 25%. If you are the only stockholder, which project would you choose?

c. Please compare you answers in part (a) and (b). Has the stockholder chosen the same project? Why? Can you relate your answer with agency problems in a corporation?