The company XYZ has a stock price of $10 and 100,000 outstanding shares. The stock beta is 1.5. The market value of XYZs debt is $600,000. The debt consists of bonds with an annual yield to maturity (YTM) of 7%. The probability of default is 5% and in case of default, the expected loss rate is 50%. The corporate tax rate is 20%. In addition, assume that the expected market risk premium is 5% and that the risk-free interest rate is 0.5% per year.

Assume now that XYZ is hit by extremely bad news. In the current situation, XYZs assets therefore have a value of $550,000, which is problematic because XYZ owes $600,000 to the debt holders, who must be repaid in the near future. The management of XYZ is considering a new risky strategy that can either increase the value of XYZs assets to $700,000 or reduce its value to $200,000. Both outcomes are equally likely. XYZ can switch to the new strategy without having to make an upfront investment.

What is the expected value of XYZs assets if the company switches to the new strategy? And What is the expected payoff to the equity holders and debt holders under the current and new strategy?