Joo Maria is an organic farmer producing free range eggs and chickens. He is the only owner of the farm and has 100% of its equity. He is worried about the bird flu epidemic and is thinking about vaccinating his hens. Without immunization, he thinks that there is a 1/3 chance that production will not be affected and earnings would be 800,000 and a 2/3 chance that production will be partly destroyed, reducing earnings to 200,000. Joo had already taken some debt to start his free range eggs production and the face value of the current outstanding debt is 600,000.

The cost of the vaccine is 50,000. Experts think that this would increase the chances of protection from 1/3 to 2/3 (i.e., 2/3 chances of getting 800,000 and 1/3 chances of getting 200,000).

a) Is it possible that Joo Marias business is in a debt overhang situation? Explain it without resorting to any calculations.

[3 marks]

b) Is it possible that Joo Marias business is in a risk shifting situation? Explain it without resorting to any calculations.

[3 marks]

c) If the immunization programme is implemented, is it still possible that Joo Marias business will face a debt overhang or a risk shifting situation once it is implemented? Explain it without resorting to any calculations.

[3 marks]

d) Is the immunization programme a positive NPV project? Will Joo execute it if he is the one that has to finance it (i.e., a project financed with resources from current equityholders)?

[4 marks]