Project A requires a €100m investment and, one year later, yields €250m, €100m or €50m, all with equal probability. A start-up with no assets is considering funding Project A with equity only or with 50% equity and 50% debt with one-year maturity and a 10% annual interest rate.

a. In each case, what are the expectation and standard deviation of shareholders’ return? Is one financing option clearly superior to the other?
b. In the second case, same question for debtholders’ return. Is the debtholders’ expected return more or less than 10%? Why?

Answer rating: 100% (QA)

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