Question: 1.Suppose the firm in question three is considering two mutually exclusive investments. Project A has an NPV of $1,200, and Project B has an NPV

1.Suppose the firm in question three is considering two mutually exclusive investments. ProjectAhas an NPV of $1,200, and ProjectBhas an NPV of $1,600. As a result of taking ProjectA,the standard deviation of the return on thefirm'sassets will increase to 55 percent peryear.If ProjectBis taken, the standard deviation will fall to 34 percent peryear.

a.What is the value of thefirm'sequity and debt if ProjectAis undertaken? If ProjectB

is undertaken?

b.Which project would the stockholders prefer? Can you reconcile your answer withthe NPV rule?

c.Suppose the stockholders and bondholders are, in fact, the same group of investors.Wouldthis affect your answer to (b)?

d.What does this problem suggest to you about stockholder incentives?

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