Consider a firm financed with an initial investment of $100 million in February 2012. In exactly one year it must decide whether to go ahead with a project that requires an additional $100 million investment. The present values (as of February 2013) of the firms payoffs from taking or not taking the additional investment in the three future states of the economy 2 are given as follows. This problem is from the book by Grinblatt and Titman, Financial Markets and Corporate Strategy, p. 641.

	Good	Medium	Bad
Value with investment	$250	$175	$125
Value without investment	$50	$50	$50

a) What is the NPV of the project in each of the states as of February 2013?

b) When financing the investment in February 2012, the original entrepreneurs believe that the manager they hire will want to fund the new investment in February 2013 even if it has a negative NPV. Why might they be concerned about this?

c) Show that if the firm issues more than $25 million in senior debt but less than $75 million to finance the original investment in February 2012, then it will be able to finance the project with junior debt in the good and medium states of the economy but not in the bad state of the economy. Assume for simplicity that the interest rate on debt is zero.