Question 1 Suppose the firm can choose one of two mutually exclusive projects A and B, each with an investment cost of $100,000. There is 50% chance project A has present value $150,000 and 50% chance it has present value $80,000. Similarly, there is 50% chance project B has present value $200,000 and 50% chance it has present value 0. The firm has a debt liability redeemable right after the investment is made, and with contractual value of $50,000. Assume risk neutrality and assume the shareholders cannot observe the present value before making the investment. Which project has the highest NPV? (15 marks) Suppose shareholders fund the new project with new equity - which project is the best for them in this case? (15 marks) Explain why you may get different conclusions to these questions. (5 marks) Question 2 Crudgington Brewery is considering adding a new ale to its product list. Adding the ale would require an investment of $0.5 million today, and would result in a cash flow of $0.6 million in one year. Crudgington's assets consist of $0.5 million in cash, as well as facilities to produce ales and ciders. Next year these facilities will produce cash flows of $5 million if UK demand is high, but only $2 million if it is low. The probability of high demand is 70%. Crudgington's only liability is debt with face value $2.5 million due in one year. The appropriate discount rate is 0% and you can ignore all cash flows more than one year in the future. (a) Just for parts (a) and (b) suppose that Crudgington has no debt outstanding. What is the expected net worth of Crudgington's owners if they do not add the new ale but rather pay the cash to themselves as a dividend? (15 marks) (b) Just for parts (a) and (b) suppose that Crudgington has no debt outstanding. What is the expected net worth of Crudgington's owners if they choose to add the new ale? (15 marks) (c) Now redo (a) with debt. What is the expected net worth of Crudgington's owners if they do not add the new ale but rather pay the cash to themselves as a dividend? (15 marks) (d) Now redo with debt. What is the expected net worth of Crudgington's owners if they choose to add the new ale? (15 marks) (e) Explain the debt overhang