A Silver Corporation Is Evaluating The Following Three Investment Strategies The Probabilities Of Success And The Cor 1 (317.99 KiB) Viewed 66 times
A Silver Corporation Is Evaluating The Following Three Investment Strategies The Probabilities Of Success And The Cor 2 (51.09 KiB) Viewed 66 times
(a) Silver Corporation is evaluating the following three investment strategies. The probabilities of success and the corresponding payoffs for each strategy are shown in the table below. In all cases, the payoff will be zero in the event of failure. Strategy A B с Probability of Success 100% 70% 40% Payoff if successful (in $ million) 60 80 120 Assume that Silver's management acts in the best interests of its equity holders. Answer the following questions (show your calculations): (i) Which strategy is optimal for Silver Corporation? (ii) Which strategy will Silver choose if it has debt outstanding of $15 million? (iii) Which strategy will Silver choose if it has debt outstanding of $30 million? (iv) Based on your answers from (i) to (iii), discuss what agency issue is relevant in this example and why it arises. (10 marks) (b) Provide an explanation to the agency issue in part (a) if equity and debt holdings are viewed as options. (6 marks) (C) “Given that financial distress is costly, firms should minimize their use of debt to avoid this cost." Comment on this statement. In your answers, identify the market imperfections where relevant and explain.
(d) Suppose that Firm A's core business lies in the development of computer software, while Firm B operates in the natural gas industry. Which firm is more likely to have a lower leverage level? Why?
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