The answer to Project Payoff

Zymase is a biotechnology start-up firm. Reseacher at Zymase must choose one of the three different research strategies. The payoffs (after-tax) and their likelihood for each strategy are shown below. The risk of each project is diversifiable.

Strategy Probability Payoff ($ Million)
A 100% 75
B 50% 140
50% 0
C 10% 300
90% 40

A. Which project has the highest expected payoff?

B. Suppose Zymase has debt of $40 million due at the time of the projects payoff. Which project has the highest expected payoff for equity holders?

C. Suppose Zymase has debt of $110 million due at the time of the projectâ??s payoff. Which project has the highest expected for equity holders?

D. If management chooses the strategy that maximizes the payoff to equity holders, what is the expected agency cost to the firm from having $110 million in debt due?

You own your own firm, and you want to raise $30 million to fund an expansion. Currently, you own 100% of the firmâ??s equity, and the firm has no debt. To raise the $30 million solely through equity, you will need to sell two-thirds of the firm. However, you would prefer to maintain at least a 50% equity stake in the firm o retain control.

a. If you borrow $20 million, what fraction of the equity will you need to sell to raise the remaining $10 million? (Assume perfect capital markets)

b. What is the smallest amount you can borrow to raise the $30 million without giving up control? (Assume perfect capital markets)