Use the information for the question(s) below.

Wildcat Drilling is an oil and gas exploration company that is currently operating two active oil fields with a market value of $200 million dollars each. Unfortunately, Wildcat Drilling has $500 million in debt coming due at the end of the year. A large oil company has offered Wildcat drilling a highly speculative, but potentially very valuable, oil and gas lease in exchange for one of their active oil fields. If Wildcat accepts the trade, there is a 10% chance that Wildcat will discover a major new oil field that would be worth $1.2 billion, a 15% chance that Wildcat will discover a productive oil field that would be worth $600 million, and a 75% chance that Wildcat will not discover any oil at all.

9) What is the overall expected payoff to Wildcat from the speculative oil lease deal?

A) $210 million

B) $275 million

C) $85 million

D) $160 million

Answer: Explanation:

10) What is the expected payoff to debt holders with the speculative oil lease deal?

A) $10 million

B) $275 million

C) $85 million

D) $160 million

Answer: Explanation:

11) What is the expected payoff to equity holders with the speculative oil lease deal?

A) $10 million

B) $160 million

C) $275 million

D) $135 million

Answer: Explanation:

12) The leverage ratchet effect would predict all of the following occurrences EXCEPT:

A) when an unlevered firm issues debt for the first time, equity holders will bear agency or bankruptcy costs

B) when additional debt is issued, the risk associated with agency or bankruptcy costs to equity holders will intensify

C) with some debt in the firm's capital structure, shareholders may have an incentive to increase leverage

D) why a firm in distress would not issue equity to reduce leverage

13) Rose Industries has a $20 million loan due at the end of the year and its assets will have a market value of only $15 million when the loan comes due. Currently Rose has $2 million in cash. Rose is considering two possible alternative uses for this cash. One possibility is to pay the $2 million out to shareholders in the form of a special dividend. The second possibility is to invest the $2 million into a project that offers a $4 million NPV. What are the payoffs to the debt and equity holders under each of the two alternatives? Which alternative would equity holders prefer? Which alternative would debt holders prefer? What is the economic term that describes this situation?

Answer: