Answer:
What is the current value of the firm to the owners?
total value - debt = $700,000 - $500,000 = $200,000
Show that this in expectation decreases the firm’s value, and explain why, in spite of that, the owners of the company would want to undertake the project.
the expected value of the company after the new project = (50% x 0) + (50% x $1,200,000) = $600,000, so the net value of the company actually decreases by $100,000.
the issue here is that if things go wrong, the owners will lose $200,000, but if things go well, then the owners equity will increase by $500,000 to a total of $700,000. In this case, the expected value of this project for the owners = (50% x -$200,000) + (50% x $700,000) = $250,000.
I am assuming that this company is some type of corporation, LLC or LLP, not a partnership or sole proprietorship. Under current bankruptcy laws, when a cooperation goes bankrupt, the owners are not personally liable for it.
