Suppose that the managers at Rearden Metal will increase risk to maximize the expected payoff to equity holders.If Rearden has $230 million in debt due in one year,then the expected value of Rearden's assets are closest to:

Question

Quizplus · Accepted Answer

B)Expected Payoff to equity holders w/o increase in risk:
E[equity] = 11ea7cce_3cdb_db73_928c_c7e64c4827f1_TB1626_11 ($200 - $200)+ 11ea7cce_3cdb_db74_928c_bb17ce2bbd50_TB1626_11 ($300 - $230)+ 11ea7cce_3cdb_db75_928c_f940bf517327_TB1626_11 ($400 - $230)= $70 million
Expected Payoff to equity holders w/increase in risk:
E[equity] = (50%)($200 - $200)+ (5%)($300 - $230)+ (45%)($400 - $230)= $80 million
Therefore Rearden's managers will increase the risk and the expected value of Rearden's assets is:
E[assets] = (50%)($200)+ (5%)($300)+ (45%)($400)= $295 million

Suppose That the Managers at Rearden Metal Will Increase Risk