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sider a firm that generates a random cash flow at date t=1. The cash flow is er 200 million or 100 million with equal probability. At t=0 the firm has debt tanding with a face value of 150 million, which is due at t=1. Assume that all stors are risk-neutral, the appropriate discount rate for all cash flows is zero, and e are no taxes. What is the value of the firm at t=0 ? What is the value of the firm's equity and the value of the firm's debt at t=0 ? [5 marks] Now assume that the firm has the opportunity to invest in two mutually exclusive projects (Projects A and B ). Each project requires financing of 30 million at t=0. If the firm invests in Project A, the cash flows at t=1 will increase by 40 million for sure. If the firm invests in Project B, the cash flow increases by 50 million in the high state and decreases by 50 million in the low state. Assume that there are covenants in place at t=0 that prohibit the issue of additional debt and dividend payments. According to the NPV criterion (i.e., whether the investment increases firm value), which project would the manager choose if they had the necessary funds? Are the shareholders willing to provide the 30 million for the investment by contributing equity capital? [9 marks]

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