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Suppose you are an investor seeking to nd new opportunities to invest. You have identied two rms: L1 Corporation and BT Enterprises. L1 Corporation is
Suppose you are an investor seeking to nd new opportunities to invest. You have identied two rms: L1 Corporation and BT Enterprises. L1 Corporation is debt free, while BT Enterprises is highly leveraged. Each rm is run by a manager/entrepreneur, who can exert two levels of effort: high or low. The project undertaken by the manager of each rm yields either a high return R3 > 0 or a low return RF 2 0, with RF 0? Explain your answer. (20% of the marks) ((1) Let us continue with the framework described in point (a) above (with no dividends and no taxes). Suppose now that you and other outside investors cannot observe the effort exerted by the managers of the two rms. The project undertaken by the manager of each rm yields either a high return R3 > 0 or a low return RF 2 0. Does the amount of leverage of each rm affect its market value? If yes, is there an optimal amount of debt to be issued? Explain your answer. (30% of the marks)
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