Calculate the expected value of the company

Reference no: EM133377545

A firm's economists estimate that recession, average-growth and strong-growth business environment are equally likely. The managers must choose between two mutually exclusive projects. Assume that the project the company chooses will be the firm's only activity and that the firm will close one year from today. The company is obligated to make a $3,800 payment to bondholders at the end of the year. The projects have different volatilities.
Calculate the expected value of the company if the low-volatility project is undertaken and if the high-volatility project is undertaken. Which of the two strategies maximize the expected firm value?
Calculate the value of equity if the low-volatility project is undertaken and if the high-volatility project is undertaken. Which project would shareholders prefer and why?
Suppose bondholders impose a bond covenant to stipulate that the bondholders can demand a higher payment if the company chooses to take on the high-volatility project. What payment to bondholders would make stockholders indifferent between the two projects?

Economy	Probability	Low-Volatility Project Payoff	High-Volatility Project Payoff
Recession	0.33	$ 3,600	$ 3,000
Average	0.33	$ 3,900	$ 4,000
Strong	0.33	$ 4,050	$ 4,550

Payment to bondholders	$ 3,800

Reference no: EM133377545

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