Question
MaxwellInc. has 500 (thousand dollars) worth of assets. The firm has just finished developing three new products that have not been subject to market testing
MaxwellInc. has 500 (thousand dollars) worth of assets. The firm has just finished developing three new products that have not been subject to market testing yet. The following table shows the possible firm value (i.e. total value of assets) within one year and the associated probability for each product. Assume discount rate = 0 for simplicity.
Product | Possible Outcomes (Firm Value) | Probability | Expected Firm Value |
A | 900 (if the product is successful) 100 (if the product fails) | 0.5 0.5 | |
B | 800 (success) 200 (fail) | 0.6 0.4 | |
C | 700 (success) 300 (fail) | 0.7 0.3 |
(a) Calculate the expected firm value for each product following the example below. Which product generates the highest expected firm value?
(b) If Maxwell currently has zero debt. Which product would be preferred by Maxwells shareholders?(Hint: shareholders prefer the product that generates the highest expected equity value. Follow the worksheet on Nov. 19thwhen calculating expected equity value)
(c) If Maxwell currently has 280 (thousand dollar) outstanding debt due within one year. Which product would be preferred by Maxwells shareholders?
(d) If Maxwell currently has 350 (thousand dollar) outstanding debt due within one year. Which product would be preferred by Maxwells shareholders?
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