Consider an all-equity firm that is run by a manager who acts in the best interest of existingshareholders. The value of the firm's assets in place is either $50 or $210. The firm has aninvestment project that requires an investment of $45. The only way to finance this project isby issuing equity to new investors in a competitive stock market. The project generates a sure,risk-free cash flow of $50 next year (i.e. this cash flow does not depend on the value of assets inplace). Everyone is risk neutral and there is no discounting.a. Suppose that everyone, including the manager, believes that the assets in place areworth $50 with probability ½ and $210 with probability 2. What fraction a of the firm'sequity has to be issued to new investors to raise $45? Does the manager want to issueequity? b. Suppose now that there is asymmetric information. While the manager knows the truevalue of the assets in place, investors continue to view both possibilities as equallylikely. Does a manager want to issue equity if assets in place are worth $210?

b) Whether the Manager Wants to Issue EquityGiven that the manager's intrinsic value is higher than…

Answered: Consider an all-equity firm that is run…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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