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Assume that a company has raised $2,000 in capital for investment projects: $1,000 is from bondholders...

Assume that a company has raised $2,000 in capital for investment projects: $1,000 is from bondholders and $1,000 is from stockholders. Assume that bonds have one year till maturity and an 8% interest rate. Project A is a low risk project with an up-front cost of $2,000. This project will give payoffs of $2,000 in weak market and $2,400 in strong market. The probabilities are 50% for each outcome. Project B is a high risk project with the same cost and payoffs equal to $0 (zero) if market is in turmoil and $4,400 if markets are stable.

a. Find expected payoff to bondholders and shareholders in case of Project A.

b. Find expected payoff to bondholders and shareholders for Project B.

c. Which investment project do shareholders prefer and why?

d. Which project do bondholders like the best? Why?

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