ATC has a value of $98,000 in a normal economy and $87,000 in a recession.The firm has $90,000 of debt.The probability of a recession is 18 percent.The firm is considering a project that would change the firm values to $105,000 in a good economy and $92,000 in a recession.If the firm accepts this project,the firm value will ________ and shareholder value will ________.
A)decrease by $2,000; decrease by $1,000
B)increase by $2,000; increase by $2,000
C)increase by $6,640; increase by $6,100
D)increase by $12,000; increase by $12,000
E)increase by $6,640; increase by $6,640

Question

Quizplus · Accepted Answer

First, we need to calculate the expected value of the firm in both good and bad economies:

Expected value in good economy = (1-0.18) x $105,000 + 0.18 x $92,000 = $98,340
Expected value in bad economy = (1-0.18) x $92,000 + 0.18 x $87,000 = $90,980

Next, we need to calculate the firm value with the project:

Value in good economy with project = $105,000
Value in bad economy with project = $92,000

Now, we can calculate the expected shareholder value with and without the project:

Without the project, shareholder value = (firm value - debt) = $98,000 - $90,000 = $8,000
Expected shareholder value with the project = (1-0.18) x ($105,000 - $90,000) + 0.18 x ($92,000 - $90,000) = $6,640

Therefore, accepting the project will increase the firm value by $6,000 and increase the expected shareholder value by $6,640.

ATC Has a Value of $98,000 in a Normal Economy