ECO359H5 : Practice problem--it's very helpful ~

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violetwoodchuck983

10 May 2011

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Eco 359 practice problems 5: (debt overhang) air ontario is in deep financial trouble. If everything goes well, next period air ontario will be worth million, but this event only occurs with probability 1/5. With probability 4/5, the company is ultimately bankrupt -- it will be worth 0. Mrs. lulu, a smart investor from macao, contemplates saving air ontario. She believes she can turn around the business, but it would cost her f = million. million with probability 1/5 + and 0 with probability 4/5 - . If mrs. lulu gets involved, she would get all extra profits that the company makes. All that stands between mrs. lulu and the company"s turnaround are the union. The firm"s cash-flows and assets in period 1 and 2 are as follows: The firm has outstanding debt with face value b repayable in period t = 2.

Related Questions

A struggling company currently has a total value of $700,000. It owes $500,000 from debt financing (assume these are loans from the bank if you wish). The value of the company to the owners is the difference between the total value and the amount owed to the debt holders. What is the current value of the firm to the owners?

Now assume that a project is presented to the owners that results in a loss of the entire value of the company with a probability of 50% and results in a gain in value of $500,000 with probability 50% (resulting in a total value of $1,200,000). Show that this in expectation decreases the firm

Suppose you are an investor with a choice between three securities that are identical in every way except in terms of their rates of return and risk, show your work.

Investment A: total return = 15 percent with probability 40percent

total return = 25 percent with probability 60 percent

Investment B: total return = 15 percent with probability 50 percent

total return = 25 percent with probability 50 percent

Investment C: total return = 15 percent with probability 60 percent

total return = 25 percent with probability 40 percent

a- Which investment provides highest expected return? Calculate the expected return of all three investments.

b- Calculate the standard deviation of all three investments.

c- Which of the three investment would you buy? Why? Explain

aquamarineskunk926

Suppose customers believe that the good they are buying is of high quality with a probability of p, and of low quality with probability 1-p. A high quality good is valued at vH and costs cH to produce, while a low quality good is valued at vL and costs cL to produce.

a) If high-quality firms do nothing to signal their quality, what price would (risk-neutral) consumers be willing to pay for the product?
b) Let cH = 9/10vH and vH = 2vL. For what values of p could consumer beliefs about quality be consistent? (That is, for what values of p is there actually a positive probability that some firms are producing high-quality goods?)

amethystjellyfish751

ECO359H5 : Practice problem--it's very helpful ~

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