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Consider a firm with $100 retained earnings.It has risky debt outstanding which requires a payment of $100 one period hence.The firm has a risky project which requires an investment of $50 today.If the project is undertaken, the shareholders get a liquidating dividend of $50 today.The state of nature one period hence is either High H or Low L with equal probability.If no investment is made today, the firm has a total value of $120 in state H or $80 in state L.If the investment is made, the firm's total value is $250 in state H or $10 in state L.Assume a discount rate of zero.
-The firm's expected total value with the investment is
A)$250
B)$200
C)$180
D)$110
E)$100

Question

Use the following information for questions 
Consider a firm with $100 retained earnings.It has risky debt outstanding which requires a payment of $100 one period hence.The firm has a risky project which requires an investment of $50 today.If the project is undertaken, the shareholders get a liquidating dividend of $50 today.The state of nature one period hence is either High H or Low L with equal probability.If no investment is made today, the firm has a total value of $120 in state H or $80 in state L.If the investment is made, the firm's total value is $250 in state H or $10 in state L.Assume a discount rate of zero.
-The firm's expected total value with the investment is
A)$250
B)$200
C)$180
D)$110
E)$100

Quizplus · Accepted Answer

The expected total value with the investment is calculated as the average of the firm's total value in both states: (0.5 * $250) + (0.5 * $10) = $125 + $5 = $130. However, since the question asks for the firm's expected total value with the investment, we must consider the initial $50 investment, which is a liquidating dividend to shareholders. Thus, the expected total value is $130 + $50 = $180.

Use the Following Information for Questions