Behavior increases the likelihood of bankruptcy

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Reference no: EM131544125

If it is managed efficiently, Remel Inc. will have assets with a market value of $48.7 million,$100.3 million, or $149.8 million next year, with each outcome being equally likely. However, managers may engage in wasteful empire building, which will reduce the firm’s market value by $5.8 million in all cases. Managers may also increase the risk of the firm, changing the probability of each outcome to 48%, 10%, and 42%, respectively.

A. What is the expected value of Remel’s assets if it is run efficiently?

Suppose managers will engage in empire building unless that behavior increases the likelihood of bankruptcy. They will choose the risk of the firm to maximize the expected payoff to equity holders.

Suppose Remel has debt due in one year as shown below. For each case, indicate whether managers will engage in empire building, and whether they will increase risk. What is the expected value of Remel’s assets in each case?

$40.7 million

$47.1 million

$90.1 million

$94.7 million

Suppose the tax savings from the debt, after including investor taxes, is equal to 8% of the expected payoff of the debt. The proceeds from the? debt, as well as the value of any tax? savings, will be paid out to shareholders immediately as a dividend when the debt is issued. What is the expected value of? Remel's assets, including the tax? savings, for each debt level in part ?(b?)? Which debt level in part?(b?) is optimal for? Remel?

Reference no: EM131544125

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