The managers of Larkin are choosing an investment strategy for the firm. Larkin has two possible projects and these are mutually exclusive. Project A has a probability of success of 0.75 and will result in a firm value of $170m if successful. If Project A is a failure, the firm value will be $30m. Project B has a 0.50 probability of success and will result in a firm value of $220 million if it succeeds. If Project B is a failure, the firm value will be zero. Larkin has debt outstanding of $104 million. The discount rate is zero and investors are risk neutral. I (a) Assuming Larkin's managers wish to maximise the wealth of their shareholders, which project will they choose? What will be the expected value of the firm and the values of its debt and equity? (7 points) (b) Suppose Larkin issues equity and buys back part of its debt so that the face value of the debt reduces to $30 million. Which project will be chosen after this transaction? Does the total value of the firm increase? What price will the debtholders demand for selling their debt back to the firm? (10 points) (c) How much will the equity holders gain or lose as a result of the transaction in (b), and how much will the debt holders gain or lose? Will Larkin's managers choose to reduce the leverage of the firm? Explain. (8 points)