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 increase risk to maximize the expected payoff to equity holders.If Rearden has $180 million in debt due in one year,then the expected value of Rearden's assets are closest to:

Question

Quizplus · Accepted Answer

C) Expected Payoff to equity holders w/o increase in risk:
E[equity] = 11ea7e54_8ca8_8bc7_ba34_9b69afde1e23_TB1620_11 ($200 - $180) + 11ea7e54_8ca8_b2d8_ba34_8f12ea460266_TB1620_11 ($300 - $180) + 11ea7e54_8ca8_b2d9_ba34_390cd516efc7_TB1620_11 ($400 - $180) = $120 million
Expected Payoff to equity holders w/ increase in risk:
E[equity] = (50%)($200 - $180) + (5%)($300 - $180) + (45%)($400 - $180) = $115 million
Therefore Rearden's managers will not increase the risk and the expected value of Rearden's assets is:
E[assets] = 11ea7e54_8ca8_b2da_ba34_e7794318b5a9_TB1620_11 ($200) + 11ea7e54_8ca8_b2db_ba34_893195c4023c_TB1620_11 ($300) + 11ea7e54_8ca8_d9ec_ba34_5d7d52c18b8e_TB1620_11 ($400) = $300 million

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