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Question 7 : Attention Industries has two divisions. Division 1 makes cleaning products and the net worth of this division ( present value of cash

Question 7: Attention Industries has two divisions. Division 1 makes cleaning products and the net worth of this division (present value of cash flows) is $3,348. Division 2 makes a chemical product. The net worth of division 2 is $1,352, absent any potential liability. There is a chance that disvision 2 could have $1,682 liability for pollution damage. The potential victims have no contractual relationship with the firm. The probability of such a loss is (0.5)/((1+s)), where s is the amount the firm spends on safety. The firm must choose the level of s . Note that the derivative of (a)/((1+s)) with respect to " s " is equal to -(a)/((1+s)^(2))
i) First, calculate the total value of the firm, including both divisions at the same time, as an equation of " s ". Second, take derivative with respect to s to find the " s " that maximizes the total value. Third, plug in the value of "s" you found into total value equation to find the maximum total value.
ii) Division 1 is riskless and has a stand-alone value of $3,348. Since all the risk comes from division 2, we must consider the chosen level of safety " s " of this unit as a stand-alone entity. First, calculate the stand-alone value of division 2 as an equation of " s ". Second, take derivative with respect to s to find the " s " that maximizes the stand-alone value of division 2. Third, plug in the value of "s" you found into the equation of stand-alone value of division 2 to find the maximum stand-alone value of division 2.(Hint: the value of division 2 is $1,352 if no liability arises. However, if a loss of $1,682 occurs it cannot pay more than the original $1,352 stand-alone value due to limited liability.) iii) What is the maximum value of the firm if we treat division 2 as a separate entity? Note that we are splitting the two divisions assuming that separated division 2 as a stand-alone firm is protected by limited liability. Hint: Add your answer to part ii) to the net worth of division 1. The probability of such a loss is 0.5(1+s), where s is the amount the firm spends on safety. The firm must choose the level of s .(Note that the derivative of a(1+s) with respect to " s " is equal to -a(1+s)2)
i) First, calculate the total value of the firm, including both divisions at the same time, as an equation of "s". Second, take derivative with respect to s to find the "s" that maximizes the total value. Third, plug in the value of "s" you found into total value equation to find the maximum total value.
ii) Division 1 is riskless and has a stand-alone value of $3,348. Since all the risk comes from division 2, we must consider the chosen level of safety "s" of this unit as a stand-alone entity.
First, calculate the stand-alone value of division 2 as an equation of "s". Second, take derivative with respect to s to find the "s" that maximizes the stand-alone value of division 2.
Third, plug in the value of "s" you found into the equation of stand-alone value of division 2 to find the maximum stand-alone value of division 2.(Hint: the value of division 2 is $2,312 if no liability arises. However, if a loss of $1,682 occurs it cannot pay more than the original $2,312 stand-alone value due to limited liability.)
iii) What is the maximum value of the firm if we treat division 2 as a separate entity? Note that we are splitting the two divisions assuming that separated division 2 as a stand-alone firm is protected by limited liability. (Hint: Add your answer to part ii) to the net worth of division 1.)
iv) Is there a gain from splitting the firm up? Calculate the numerical value of gain/loss.(Hint: It is the difference between the maximum total value without split up that you found in i) and the maximum total value with split up that you found in iii).)

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