Burger Queen has a value of $26,000 in a good economy and $17,000 in a recession.The firm has $20,000 of debt.The probability of a recession is 50 percent.The firm is considering a project that would change the firm values to $27,000 in a good economy and $15,000 in a recession.Will shareholders be willing to accept this project? Why or why not?
A)No;Because the project will lower firm value by $500
B)No;Because the project will lower shareholder value by $500
C)No;Because the firm will be worth less in a recession than it is currently
D)Yes;Because the project will increase both firm and shareholder value by $500
E)Yes;Because shareholder value will increase $500 at a cost of $1,000 to the bondholders

Question

Quizplus · Accepted Answer

Current firm value = .50 × $26,000 + .50 × $17,000 = $21,500Proposed firm value = .50 × $27,000 + .50 × $15,000 = $21,000Change in firm value = $21,000 - 21,500 = -$500Current shareholder value = .50 × ($26,000 - 20,000)+ .50 × $0 = $3,000Proposed shareholder value = .50 × ($27,000 - 20,000)+ .50 × $0 = $3,500Change in shareholder value = $3,500 - 3,000 = $500Current bondholder value = .5 × $20,000 + .5 × $17,000 = $18,500Proposed bondholder value = .5 × $20,000 + .5 × $15,000 = $17,500Change in bondholder value = $17,500 - 18,500 = -$1,000

Burger Queen Has a Value of $26,000 in a Good