The managers of a firm are asked to consider two possible new product lines for the firm. Project 1 is quite risky and may result in a market value for the firm of $50 million in two years, or nothing. Project 2 is much more certain in outcome and may result in a firm market value as high as $25 million or as low as $15 million.
The face value of the company's debt, payable in two years, is $20 million.
a. Explain what are the possible payoffs to the bondholders under projects 1 and 2?
b. Find what are the possible payoffs to the shareholders under projects 1 and 2?