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EpiscoWhat EpiscoWhat
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7 years ago
Suppose that the managers at Rearden Metal will engage in empire building unless that behavior increases the likelihood of bankruptcy. If Rearden has $190 million in debt due in one year, then the expected value of Rearden's assets is closest to:
A) $265 million
B) $280 million
C) $295 million
D) $300 million
Textbook 
Corporate Finance: The Core

Corporate Finance: The Core


Edition: 4th
Authors:
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#1
7 years ago
D
Explanation:  D) In this case the probability of bankruptcy is increased, since in the event of the worse outcome with empire building Rearden's assets would only be worth $200 - $20 = $180 million which will not cover the repayment of debt. Therefore the management team will not engage in empire building.
The expected value is just the weighted average of the possible outcomes.
E[assets] =  ($200) +  ($300) +  ($400) = $300 million
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