Answer Happy

A firm has $50 million in cash that can be used as a dividend
payment or to fund a safe investmentthat will return 10% next year.
The firm also has a balloon debt payment of $100 million due
next year as well. Suppose that
next year, an expansion or
recession is equally likely whetheror
not the firm funds the investment. If the investment is not
funded and an expansion occurs,the value of the firm’s assets will
be $150 million. This will be divided amongst the debt
holdersand shareholders accordingly. If a recession occurs,
the assets will be worth $50 million. If the project is
funded, the payoffs will increase in each state by the gross
investment return. Assume the discount rate is 10%.
a) How much do shareholders expect to gain if the
investment is funded vs unfunded? Should shareholders take
the dividend or fund the investment?
b) What is the break-even investment return amount that
will make the shareholders indifferent between funding and not
funding the project?