The following questions are based on the information below: Xphone Corporation has two mutually exclusive $150 million investment opportunities, R and S, which it plans to fund with debt. Project S pays off $180 million for certain, and project R pays off only $60 million when the economy is poor and $270 million when the economy is good. For simplicity, assume that investors are risk neutral.

Question 1. Which project has higher NPV, assuming the economy is equally likely to be favorable or unfavorable and the discount rate is 0 percent?

A. Project S.

B. Project R.

C. Project S and R have same NPV.

D. Cannot be determined.

Question 2. Suppose Xphone can raise the $150 million by issuing a bond with a face value of $150 million (because the lender naively believes the company will take the safe project). Which project will Xphone shareholders prefer? Note that this question asks you which project gives higher payoff to shareholders, not which project gives higher NPV. A. Project S.

B. Project R.

C. Xphone shareholders will be indifferent between Project S and R.

D. Cannot be determined.

Question 3. What is the expected profit (or loss) to the nave lenders? Note that the nave lender believes the company will take the project with higher NPV, and the profit (or loss) to the lenders equals to the expected payoff minus the amount of loan borrowed from the lenders.

A. $0 million

B. -$25 million

C. -$45 million

D. None of the above Question

4. Now suppose the debtholders are sophisticated. What interest rate must the debt holders be promised?

A. 50%

B. 60%

C. 70%

D. None of the above