Problem 5 (10%) Your firm currently faces financial distress opportunity that requires equity holders to generate a risk-free return of 50%. Assume that of the year is shown in the table below: financial distress with $1 million in debt. Your firm has an investment we equity holders to contribute an initial investment of $100,000 and will U SUN. Assume that the current risk-free rate is S. Their payoff at the end Existing New project Total female Debe Equity Without New Project 900 With New Project fie., issuing equity). 900 900 ur firm is considering in reducing leverage from $1 million to $400,000 by buying back debt 900 150 TOSO 1000 11) Show that the shareholders would not gain by reducing leverage, even though firm value would increase by eliminating the cost of underinvestment? (5%) olders do not have an incentive to decrease leverage when they are in (2) Explain why the shareholders do not have an incentive to decrease leverage financial distress, even if it will increase the value of the firm? (5%) Problem 5 (10%) Your firm currently faces financial distress opportunity that requires equity holders to generate a risk-free return of 50%. Assume that of the year is shown in the table below: financial distress with $1 million in debt. Your firm has an investment we equity holders to contribute an initial investment of $100,000 and will U SUN. Assume that the current risk-free rate is S. Their payoff at the end Existing New project Total female Debe Equity Without New Project 900 With New Project fie., issuing equity). 900 900 ur firm is considering in reducing leverage from $1 million to $400,000 by buying back debt 900 150 TOSO 1000 11) Show that the shareholders would not gain by reducing leverage, even though firm value would increase by eliminating the cost of underinvestment? (5%) olders do not have an incentive to decrease leverage when they are in (2) Explain why the shareholders do not have an incentive to decrease leverage financial distress, even if it will increase the value of the firm? (5%)