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Choosing Strategies

A firm has debt maturing two years from now with face value $100 million. The firm can choose one of two strategies, the first offering a 60% chance of total payoff $120 million and a 40% chance of $105 million, either to come in two years. The second strategy offers a payoff in two years that is $160 million with 70% probability and $50 million with 30% probability. Neither of these strategies involves market risk, and the firm will have no going-concern value beyond year 2. Equity holders would choose Strategy __________, while if managers acted in the interest of the firm as a whole, they would select __________.

a. 1, Strategy 1
b. 1, Strategy 2
c. 2, Strategy 1
d. 2, Strategy 2
e. 2, either strategy


Solution Preview

The theoretical answer to the question is: The Equity holders will choose the one with the most return and ...

Solution Summary

The solution tells you the correct answer and explains how it was found and why it is correct.