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Incredible Inc.currently owes its creditors $300.The manager, Mr.Jack Smith can manage it for a period at a personal cost of $110.It has an asset which will generate $450 with probability 0.7 or $200 with probability 0.3 under Mr.Smith's stewardship.Under any other management, the asset will have a sure liquidation value of $250.Everybody is risk neutral and the riskless rate is zero.
-What is the payoff to Mr.Smith if he continues to manage under the current term?

Question

Use the following information for questions 
Incredible Inc.currently owes its creditors $300.The manager, Mr.Jack Smith can manage it for a period at a personal cost of $110.It has an asset which will generate $450 with probability 0.7 or $200 with probability 0.3 under Mr.Smith's stewardship.Under any other management, the asset will have a sure liquidation value of $250.Everybody is risk neutral and the riskless rate is zero.
-What is the payoff to Mr.Smith if he continues to manage under the current term?

Quizplus · Accepted Answer

If Mr. Smith manages the company, the total payoff of the company will be:
- If the asset generates $450: $450 - $300 (to the creditors) - $110 (personal cost) = $40
- If the asset generates $200: $200 - $300 - $110 = -$210
So, the expected payoff for Mr. Smith is:
(0.7 * $40) + (0.3 * -$210) = -$5
Therefore, the best choice is for Mr. Smith to not continue managing the company under the current terms, as he would have a negative expected payoff.

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