Answer:
Explanation:
Project A:
Has a certain payoff of $50 in 1 year
Project B:
Has a 50% chance (0.5 probability) of generating $100 in a year and the remaining 50% probability that it generates $0 in a year.
Also, the company has an outstanding debt of $50.
(1) Which project will shareholders prefer?
Shareholders will prefer Project B
Why?
A shareholder is not a salary earner or employee in the firm. The focus of a shareholder is dividends. Dividends come to shareholders when the company makes good sales or profits. Now, business isn't good all the time (internal and/or external factors affect profits either positively or negatively, at different times). Shareholders will prefer to benefit from the 50% probability case of $100 generation and also lay low if the other probability of $0 occurs.
(2) Debt holders will prefer Project A.
Because a $50 payoff is sure every year, in Project A, debt holders will prefer Project A. If project B were to be invested in and the $0 probability occurs, debt holders will be held strongly to pay their debts.
(3) Which project will the financial manager prefer?
Project B
Why?
Because if $100 is made in a year, he/she will be able to plan with it, and gauge the company for when there'll be $0 generation.
