Question
Hi all can someone explain me this example if possible with understandable intermediate steps! Thank you very much! Laura establishes a limited liability company today
Hi all can someone explain me this example if possible with understandable intermediate steps!
Thank you very much!
Laura establishes a limited liability company today (t=0) and expects the following state-dependent company asset values after one period (t=1): State High Middle Low Asset value of the company (in millions)High 50 Middle 30 Low Asset 10 All states are equally likely, the participants are risk-neutral and the relevant interest rate is 10%. In order to take advantage of the tax benefit, Laura would like to finance a part of the start-up costs at t=0 through 12 000 000 of debt. If the company value at the end of the period is lower than the claims of creditors, the company goes bankrupt. The bankruptcy cost at t=1 amount to 6 000 000 and are borne by the shareholders (hint: illustrate the fact that shareholders carry the bankruptcy costs with the negative value of equity in case of default) and the assets of the company are distributed to the creditors. Risk control could smooth the company end values to 35 000 000, 30 000 000 and 25 000 000 respectively and would cost 1 000 000 today. Should Laura invest in risk control?
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