Zymase is a biotechnology start-up firm. Researchers at Zymase must choose one of three dif- ferent...

Question

Zymase is a biotechnology start-up firm. Researchers at Zymase must choose one of three dif- ferent 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 (in $ 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 project’s payoff. Which proj- ect has the highest expected payoff for equity holders?

c. Suppose Zymase has debt of $110 million due at the time of the project’s payoff. Which project has the highest expected payoff 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 $40 million in debt due? What is the expected agency cost to the firm from having $110 million in debt due?

Robert · Accepted Answer

SOLUTION:
a) E(A) = $75 million  
 
E(B) = 0.5 × 140 = $70 million
E(C) = 0.1 × 300 + 0.9 × 40 = $66 million
Project A has the highest expected payoff.
b) E(A) = 75 – 40 = $35 million  
 
E(B) = 0.5 × (140 – 40) = $50 million
E(C) = 0.1 × (300 –40) + 0.

Zymase is a biotechnology start-up firm. Researchers at Zymase must choose one of three dif- ferent research strategies. The payoffs (after-tax) and their likelihood for each strategy are shown below....

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