Question
ABC is a chemical start-up firm. Researchers at ABC must choose one of three different research strategies. The payoffs (after-tax) and their likelihood for each
ABC is a chemical start-up firm. Researchers at ABC must choose one of three different research strategies. The payoffs (after-tax) and their likelihood for each strategy are shown below. The risk of each project is diversifiable.
Strategy | Probability (%) | Payoff ($ million) |
A | 100 | 75 |
B | 50 | 140 |
50 | 0 | |
C | 10 | 300 |
90 | 40 |
a. Which project has the highest expected payoff? b. Suppose ABC has debt of $40 million due at the time of the project's payoff. Which strategy has the highest expected payoff for equity holders? (If payoff < debt, net payoff is zero.) c. Suppose ABC has debt of $110 million due at the time of the project's payoff. Which strategy has the highest expected payoff for equity holders? (If payoff < debt, net payoff is zero.) d. If executives choose the strategy that maximizes the payoff to equity holders, what is the expected agency cost to the firm from having $40 million in debt due and what is the expected agency cost to the firm from having $110 million in debt due?
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