AlL Coporatin has to mutually exclusive $80 million investment opportunities, R and which t lans to fund with debt. Project S pays off $88 million for certain, and project R pays off only $50 million when the economy is poor and $120 million when the economy is good, For simplicity, assume that investors are risk neutral.

Question 1. Assuming the economy is equally likely to be favorable or unfavorable and the discount rate is percent, and suppose A&L Corporation can raise the $80 illion by ising a bond with a face value of $80 million because the lender naively believes the company will take the safe project). Which project will A&L shareholders preter? Note that this question asks you which project gives higher payoff to shareholders, not which project gives higher NPV

A) Project S

B) Project R

c) The shareholders will be indifferent between Project. S and R.

D)Cannot be determined.

Question 2. What is the expected profit (or loss) to the naive lenders? Note that the naive lender believes the company will take the project with higher NPV, and the profit or los to the lenders equals to the expected payoff minus the amount of loan borrowed from the lenders.

A) $0 million

B)$ -15 million

c) $-25 million

D) None of the above.

Question 3. Now suppose the debtholders are sophisticated. What is the lowest interest rate must the debt holders be promised?

A) 37.5%

B) 38,5%

) 39.5%

D) None of the above