Question
A firm has $100 in cash and a project that costs $100 and pays either $110 or $200 with equal probabilities at time 1. The
A firm has $100 in cash and a project that costs $100 and pays either $110 or $200 with equal probabilities at time 1. The firm also has a bond due at time 1 with a promised payment of $150. Management has two options. The first is to forego the project and pay out the $100 in cash to its shareholders today. The second is to take the project. The cost of capital for the project is 15%. What is the NPV assuming risk neutrality? ) If management is acting in the shareholders best interests, which option will they choose? What if they are acting in the creditors best interests? Why? Provide support for your answer using mathematical calculations.
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