Fountain Corporation’s economists estimate that a good businessenvironment and a bad business environment are equally likely forthe coming year. The managers of the company must choose betweentwo mutually exclusive projects. Assume that the project thecompany chooses will be the company’s only activity and that thecompany will close one year from today. The company is obligated tomake a $5,100 payment to bondholders at the end of the year. Theprojects have the same systematic risk but different volatilities.Consider the following information pertaining to the twoprojects:

Economy	Probability	Low-Volatility Project Payoff	High-Volatility Project Payoff
Bad	.50	$ 5,100	$ 4,500
Good	.50	6,100	6,700

a.	What is the expected value of the company if the low-volatilityproject is undertaken? The high-volatility project? (Do notround intermediate calculations and round your answers to thenearest whole number, e.g., 32.)

  

Expected value of the company
Low-volatility project	$
High-volatility project	$

  

b.	What is the expected value of the company’s equity if thelow-volatility project is undertaken? The high-volatility project?(Do not round intermediate calculations and round youranswers to the nearest whole number, e.g., 32.)

  

Expected value of the company's equity
Low-volatility project	$
High-volatility project	$

   

c.	Which project would the company’s stockholders prefer?
	High-volatility project Low-volatility project

  

d.

Suppose bondholders are fully aware that stockholders mightchoose to maximize equity value rather than total company value andopt for the high-volatility project. To minimize this agency cost,the company's bondholders decide to use a bond covenant tostipulate that the bondholders can demand a higher payment if thecompany chooses to take on the high-volatility project. Whatpayment to bondholders would make stockholders indifferent betweenthe two projects? (Do not round intermediate calculationsand round your answer to the nearest whole number, e.g.,32.)

  

Payment to bondholders

$