Boring Inc. works to enhance the quality of living by significantly reducing commute times in US. To achieve this goal, the company plans to build a network tunnels that will effectively transform the transportation network into a three-dimensional space. This is a 1% (one percent) chance that it will succeed, but if it does, the return on firm’s current assets will be phenomenal. Assume that the firm currently has assets in place that will be worth either $1 trillion (“good state”) if it succeeds or $500 million (“bad state”) if it fails in the next period. The Boring Inc. has debt outstanding with a face value of $600 million that must be repaid next period. The discount rate is zero and the interest rate on a risk-free bond is 0.

Boring Inc. now decided to expend to Canada. This expansion requires an investment of $250 million today. This project generates $300 million in both good and bad state, and they can finance the project only by issuing equity.

How much value does old shareholders lose (in millions) from the new project?

Answer rating: 100% (QA)

The certainty equivalent CE is the expected value of these outcomes ... View the full answer