Xbox is a company in a very bad financial position. At the current date, date 0, xBox owes the bank 2. At date 1, xBox owes the bank k = 50.

At date 0, xBox has no assets and no cash. Its only future cash flow will occur at date 1. This cash flow depends on the state of the world at date 1, which can either be Good, G, or Bad, B. States B and G are equally likely, i.e., p(B) = p(G) = 1/2, Assume that xBox values cash flows simply based on their expected value and that xBox pays no taxes.

xBoxs cash flow at date 1, which we will call xR, will equal 100 if the state is Good, i.e., xR(G) = 100, and, if the state is Bad, Xboxs cash flow will equal 0, i.e., xR(B) = 0.

xBoxs owner at date 0 must decide on whether to reach into his pocket and pay the 2 to the bank or declare bankruptcy and walk away from the firm. If xBox declares bankruptcy, the bank will take over the firm.

a. Should the owner pay the 2 to the bank?

b. Make one change in the problem: assume that cash flows at date 1 are given by xS(G) = 52 and xS(B) = 48. Should the owner pay the 2 or declare bankruptcy.

c. How does the riskiness of cash flows affect willingness of of the owner to declare bankruptcy (no maths required)