One subsidiary of Gianluca SpA is about to be closed. You must decide between two mutually exclusive projects for the final year of its life, which are still important for the rest of the conglomerate. The two projects have different levels of risk and their ultimate payoff depends on the state of the economy in the country of the subsidiary. The company management believe that a positive economic state (Growth) and a negative economic state (Recession) are equally likely. The pay-off profiles of each of the two projects is summarised in the table below:

State of the Economy Payoff Low Risk Project Pay-off High Risk Project Recession 300,000 100,000 Growth 700,000 800,000

The subsidiary is partly financed by debt and the company must make a payment of 250,000 to its bond holders at the end of the year. At that time, the company will cease trading and be liquidated. Assume that whichever project the subsidiary undertakes it will be the only thing the company does in the coming year.

a) Which project should Gianluca SpAs subsidiary undertake in order to maximise the value of the company? Show your workings. (7 Points)

b) Which project should the subsidiary undertake in order to maximise the value of shareholders equity? Show your workings and explain the implications for Gianluca SpA.