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There are multiple projects that can be classified into safe projects and risky projects. A...

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Finance

There are multiple projects that can be classified into safe projects and risky projects. A safe projects cash flow next year will be $8,000 with probability 0.3 and $22,000 with probability 0.7. A risky projects cash flow next year will be $5,000 with probability 0.5 and $25,000 with probability 0.5. Each firm can invest in only one project. LoDebt Corporation has debt obligation of $11,000 next year while HiDebt Corporation has debt obligation next year of $18,000. Each firm will choose exactly one project and the cash flow from the chosen project will be the only cash flow for the firm. Assume that each firms shareholders decide which project to accept. There are no direct costs of bankruptcy. All investors are risk-neutral and require a return of 12%. Ignore taxes. Determine which type of projects will shareholders of LoDebt choose and which type of project will shareholders of HiDebt choose. What is the value of each firm? Discuss why the values are same or different.

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