Butterfly plc is financed by a $***$ combination of debt and equity. The company

has $110$ m of debt at present; this is maturing at the end of the financial year. The

company has an opportunity to invest in a risk free investment opportunity with

a cash outlay of $10$ million for a certain cash flow of $20$ million at the end of

the financial year. $***$ The capital for this investment will come from the

company's equityholders. The firm also has in place other assets that generate

some cash flows. The level of these latter cash flows is dependent upon the state

of the economy, of which three possible states: S$1,$ S$2$ and S$3.$

The table below details the cash flow positions of the company associated with

the three possible economic $***$ states together with their respective

probabilities of occurrence.

Probability of occurrence

S$11S2S3$

Cash flow $of$ assets already $in$ place $(m),50,80,120$

Required:

a$.$ Discuss the underinvestment $***$ problem in the context of firms' capital

structure decisions and agency problems between debt$-$ and equity $-$

holders.