Question
Consider the following world. There are two time periods, t = 0 (today) when the decisions are made; and t = 1 the (uncertain) future.
Consider the following world. There are two time periods, t = 0 (today) when the decisions are made; and t = 1 the (uncertain) future. In the future, at t = 1, the world can be in one of the two states. The UP state (happens with probability 0.5) or the DOWN state (happens with probability 0.5). Assume that the interest rate is zero (i.e., no need to discount between t = 1 and t = 0). Assets of the firm will equal $300 in the UP state (at time 1) or $100 in the DOWN state (at time t = 1). The firm has Debt, which needs to be paid at t = 1. The amount owed (face value of debt) equals $200.00. Debt must be paid in full (from Assets of the firm) before any assets are paid to Equity. The firm has Equity, which receives all Assets after the Debt is paid at t = 1; if there are no Assets left, after the Debt has been paid, then Equity receives $0.
The project payoffs (at time t = 1) are in addition to the payoffs from the existing assets of the firm. In the UP state, the payoff on the project equals -$50.00 (negative $50.00). In the DOWN state, the payoff on the project is $100.00 (positive $100.00).
[4.4. 2 points] What is the PV (at t = 0) of the project described above? Based on the PV of the project, should the company accept (take) the project or not? In this question, your calculations are based only on the values of the project (just the project, without the assets of the firm).
[4.5. 2 points] Suppose the firm takes the project. What is the PV (at t = 0) of the firm with the project accepted? Here you are working with assets of the firm and the project payoffs.
[4.6. 2 points] Suppose the firm takes the project. What is the PV of Debt, PV(Debt) (at t = 0)?
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