A firm is about to issue debt with a face value of $100. Everybody knows that immediately after the issue it will have to choose between two investment projects. One project will have a 50% chance of ending up with 0 dollars, and 50% chance of $150, whereas the other will have a 70% chance of $100 and 30% of $101. Which project will shareholders choose? Which one will be preferred by bondholders? (please provide a calculation)

If we assume risk neutrality and a zero interest rate (no discounting) what will be the value of debt the firm can issue, assuming that bondholders are not cheated? If the firm can include in the debt offering a covenant that prevents it from taking any projects that include a risk of ruin (that is, 0 for everybody), how will that change debt value for the same promised payment of $100 and same choice of projects (please provide a calcualtion) . Extra credit: Does such a covenant make sense for shareholders?

b) A new tax law will equate the tax rates of indviduals on interest income and equity income (capital gains and dividends). If you believe the Miller model, what should all firms in the economy do? Please provide a short paragraph you can prove within the model.