Question
Q2. Apex Corporations economic unit estimates that the probability of a good business environment next year is equal to the probability of a bad environment.
Q2. Apex Corporations economic unit estimates that the probability of a good business environment next year is equal to the probability of a bad environment. Knowing that, the managers of Apex must choose between two mutually exclusive projects, project A and project B, which will provide the only assets of the firm. Apex has outstanding a zero coupon bond with a face value of $300m, maturing next year, when the project chosen will have its only payoff. The firm has currently available cash of $200m. Project A requires an initial investment of $100m, while project B requires $200m; final payoffs one year from now are: State of the economy: Good Bad Probability: 1/2 1/2 Project A $400m $300m Project B $800m $50m The appropriate discount rate for these projects is the risk-free rate, which is assumed to be equal to zero. There are no taxes. Answer the following questions: a) Which project maximizes the market value of the firm? b) Which project maximizes the market value of equity? c) Explain your results. d) Discuss how the use of a convertible bond may have been preferable in this case.
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