J.Spartan Inc., a supplier of paper products, is facing financial distress. It currently has a loan outstanding with face value of $1 Million due at the end of the year, however, at that time, the market value of its assets will only be $900,000. To salvage the firm, John Spartan the owner of the firm, is considering going into the lemonade business for a year. This venture has no upfront costs, and with 50% probability the market value of the J.Spartan Inc. assets will be $1.3 Million (otherwise the assets will be worth only $300,000).

a) What is the value of this firm? What is the value of John's equity? What is current value of the loan outstanding?

b) Is going into lemonade business a value enhancing strategy for the firm? Explain. What would be the value of the firm if this investment strategy is implemented? What would be the current value of the firm's debt, and equity, as a result. Would John, the manager, pursue this new strategy? Why?