Objective is to maximize shareholder current wealth

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Reference no: EM131931926

Firm C has a total present value of 100 and has debt with face value equal to 99. C's value also follows a binominal process, and over a time horizon of 5 years, it can either increase to 150 (good state) or decrease to 66,67 (bad state). The probability of an increase in value is 80%. The risk free interest rate is 5%. C's assets include the amount 25 in idle cash, currently earning the risk free rate (the possible firm values at the end of the time horizon include the payoffs of this investment). Firm C's management considers two alternative uses of this cash: 1. Either, it can use it to pay dividendd to shareholders in the current period or, 2. It has the opportunity to invest the cash in a riskless NPV>0 project which in 5 years has a payoff of 40 in both states. Which of these alternatives will C's management choose if its objective is to maximize shareholder's current wealth?

Reference no: EM131931926

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