Use the following information to answer the question(s) below.
If managed effectively, Rearden Metal will have assets with a market value of $200 million, $300 million, or $400 million next year, with each outcome being equally likely. Managers, however, may decided to engage in wasteful empire building, which will reduce Rearden's market value by $20 million in all cases. Managers may also increase the risk of the firm, changing the probability of each outcome to 50%, 5%, and 45% respectively.
-Suppose that the managers at Rearden Metal will engage in empire building unless that behavior increases the likelihood of bankruptcy.If Rearden has $190 million in debt due in one year,then the expected value of Rearden's assets are closest to:

Question

Quizplus · Accepted Answer

D) In this case the probability of bankruptcy is increased, since in the event of the worse outcome with empire building Rearden's assets would only be worth $200 - $20 = $180 million which will not cover the repayment of debt. Therefore the management team will not engage in empire building.
The expected value is just the weighted average of the possible outcomes.
E[assets] = 11ea7e54_8ca8_3da4_ba34_efe5648e882c_TB1620_11 ($200) + 11ea7e54_8ca8_64b5_ba34_f3c067190033_TB1620_11 ($300) + 11ea7e54_8ca8_64b6_ba34_ef36971898b9_TB1620_11 ($400) = $300 million

Use the Following Information to Answer the Question(s) Below