Consider the following risky scenarios for future cash flows for a firm: Project 1
Question:
Consider the following risky scenarios for future cash flows for a firm:
Project 1 Project 2
ProbabilityCash Flow ($) Probability Cash Flow ($)
0.3 2,000 1/3 -7,000
0.5 4,000 1/3 5,000
0.2 6,000 1/3 4,000
Given that the firm has fixed debt payments of $3,000 and limited liability, which scenario (project) will shareholders choose and why?
B.You have estimated the following probabilities for earnings per share of companies A and B:
Probability A ($/share)B ($/share)
0.1 0.5 1.0
0.2 1.5 1.5
0.4 2.0 2.5
0.3 2.5 4.0
Compare companies A and B, using the stochastic dominance criteria. Would your answer be the same if you were asked to use the mean-variance criterion?
Financial Theory and Corporate Policy
ISBN: 978-0321127211
4th edition
Authors: Thomas E. Copeland, J. Fred Weston, Kuldeep Shastri