A firm (with face value of debt = $100) is to choose between two mutually exclusive projects:

PROJECT A: LOW-RISK

Recession: Probability (.5), Firm Value (100), Stock Value (0), Debt Value (100)

Boom: Probability (.5), Firm Value (200), Stock Value (100), Debt Value (100)

PROJECT B: HIGH-RISK

Recession: Probability (.5), Firm Value (50), Stock Value (0), Debt Value (50)

Boom: Probability (.5), Firm Value (240), Stock Value (140), Debt Value (100)

Answer the following questions:

a)Consider first the case where the firm is an all-equity firm. Which project will the firm choose?

b)With the current face value of debt = $100, which project will it implement if management is to maximize shareholders' value?

c)What is the price debt holders will pay for the debt?

d)Calculate the agency cost of debt.