Suppose that USB Corp has $100m invested in 8% risk-free bonds that mature in one-year. The company also has $80m in debt outstanding that will also mature in a year. USB shareholders are considering selling the $100m in debt and investing in a project that has a 60% chance of returning $200m and a 40% chance of returning $2m. Agency costs: What will the equity value of USB be in one-year without shareholders taking on the project?
A) $100m
B) $80m
C) $20m
D) $8m

Question

Quizplus · Accepted Answer

Without taking on the project, USB Corp will receive $108m from the risk-free bonds ($100m principal + $8m interest). After paying off the $80m debt, the equity value will be $28m.

Suppose That USB Corp Has $100m Invested in 8% Risk-Free