As explained in the chapter, the use of debt offers shareholders the opportunity to earn higher returns, but it also creates higher risk. Different individuals have different preferences for risk and return, so determining the optimal balance of risk and return is not an easy matter. To illustrate the problem, conduct the following exercise in a small group.

You are offered the opportunity to participate in one of the following lotteries that require an investment of $10,000: 1. There is a 100 percent probability that you will get back SI 0.500 at the end of one year. 2. There is a 50 percent probability that you will get back $10,000 at the end of one year and a 50 percent probability that you will get $12,000. 3. There is a 50 percent probability that you will get back $8,000 at the end of one year and a 50 percent probability that you will get $16,000.

Determine which of the three lotteries you prefer and then attempt to reach a group consensus as to which lottery the group will accept.