If managed eectively, Rearden Metal will have assets with a market value of $200 million, $300 million, or $400 million next year, with each outcome being equally likely. Managers may increase the risk of the rm, changing the probability of each outcome to 50%, 5%, and 45% respectively.
1. What is the expected value of Rearden's assets if it were run eciently?
2. Suppose that the managers at Rearden Metal can increase risk to maximize the expected payo to equity holders. If Rearden has $180 million in debt due in one year, what is the expected value of the company's assets? Will they increase the company's risk?
3. Suppose now that the company has a $230 million in debt due in one year. Does your answer to the previous question change? Explain.