TDC Inc. has $110 million in debt and $90 million in equity(stock). The debt matures in one year and has a 10% interest rate, so the company is promising to pay back $121 million to is debtholders one year from now.. The company is considering 2 possible investments, each of which will require an upfront cost of $200 million. Each investment will last for one year and the cash flow from each investment depends on the strength of the overall economy. There is a 40% chance that the economy will be weak and 60% chance it will be strong.

Here are the expected cash flows(all dollars are in millions)from the 2 investments.

investment a-cash flow in one year if the economy is weak($50) cash flow in one year if the economy is strong($180) expected cash flow($128)

investment b-cash flow in one year if the economy is weak($110) cash flow in one year if the economy is strong($140) expected cash flow($128)

Assume that if TDC Inc does not have enough funds to pay off it debtholders one year from now, then it will declare bankruptcy. If Bankruptcy is declared, the debtholders will receive all available funds and the stockholders will recieve nothing.

a)Which project is more risky? Briefly explain why.

b)If the company invest in Investment A. What is the expected cash flow to the firms debtholders. What is the expected payoff to the firms stockholders?

c)If the company invest in Investment B. What is the expected cash flow to the firms debtholders? What is the expected payoff to the firms stockholders?

d)Would the debtholders prefer the company managers select Project A or Project B? Briefly explain your reason.

e)Explain why the companys managers acting on behalf of the stockholders might select the project that has greater risk.