Problem 3 A firm (with face value of debt = $100) is to choose between two mutually exclusive projects: PROJECT A: LOW-RISK RECESSION BOOM PROBABILITY Firm Value 0.5 100 0.5 200 Stock Value 0 100 Debt Value 100 100 PROJECT B: HIGH-RISK + RECESSION BOOM PROBABILITY 0.5 0.5 Firm Value 50 240 Stock Value 0 140 Debt Value 50 100 Answer the following questions: a) Consider first the case where the firm is an all equity firm. Which project will the firm choose? b) With the current face value of debt = $100, which project will it implement if management is to maximize shareholders' value? c) What is the price debt holders will pay for the debt? d) Calculate the agency cost of debt. Problem 3 A firm (with face value of debt = $100) is to choose between two mutually exclusive projects: PROJECT A: LOW-RISK RECESSION BOOM PROBABILITY Firm Value 0.5 100 0.5 200 Stock Value 0 100 Debt Value 100 100 PROJECT B: HIGH-RISK + RECESSION BOOM PROBABILITY 0.5 0.5 Firm Value 50 240 Stock Value 0 140 Debt Value 50 100 Answer the following questions: a) Consider first the case where the firm is an all equity firm. Which project will the firm choose? b) With the current face value of debt = $100, which project will it implement if management is to maximize shareholders' value? c) What is the price debt holders will pay for the debt? d) Calculate the agency cost of debt