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Ralston Enterprises has assets that will have a market value in one year as follows:
Probability
2%
6%
25%
34%
Value (in $ million)
70
80
90
100
110
120
130
That is, there is a 2% chance the assets will be worth $70 million, a 6% chance the assets will be worth $80 million, and so on. Suppose the CEO is contemplating a decision that will benefit her personally but will reduce the value of the firm's assets by $10 million. The CEO is likely to proceed with this decision unless it substantially increases the firm's risk of bankruptcy.
a. If Ralston has debt due of $75 million in one year, the CEO's decision will increase the probability of bankruptcy by what percentage?
b. What level of debt provides the CEO with the biggest incentive not to proceed with the decision?
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