There are multiple projects that can be classified into safe projects and riskyprojects. A safe project's cash flow next year will be $4,000 with probability 0.3 and $6,000with probability 0.7. A risky project's cash flow next year will be $1,500 with probability 0.5and $8,500 with probability 0.5. Each firm can invest in only one project. LoDebt Corporationhas debt obligation of $2,000 next year while HiDebt Corporation has debt obligation nextyear of $3,000. Each firm will choose exactly one project and the cash flow from the chosenproject will be the only cash flow for the firm. Assume that each firm's shareholders decidewhich project to accept. There are no direct costs of bankruptcy. All investors are risk-neutraland require return of 20%. Ignore taxes. Determine which type of project will shareholdersof LoDebt choose and which type of project will shareholders of HiDebt choose. What is thevalue of each firm? Discuss why the values are same or different.

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To determine which type of project shareholders of LoDebt and HiDebt would choose we need to compare ... View the full answer