Zymase is a biotechnology startup firm. Researchers at Zymase must choose one of
ID: 2752730 • Letter: Z
Question
Zymase is a biotechnology startup firm. Researchers at Zymase must choose one of three different 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
($million)
A
100%
75
B
50%
130
50%
0
c
10%
310
90%
30
a.Which project has the highest expected payoff?
b. Suppose Zymase has debt of $30 million due at the time of the project's payoff. Which project 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 $30 million in debt due? What is the expected agency cost to the firm from having $110 million in debt due?
a.Which project has the highest expected payoff?
The project with the highest expected payoff is: (Select the best choice below.)
A. Project A
B. Project B
c. Project C
b. Suppose Zymase has debt of$30 million due at the time ofthe project's payoff. Which project has the highest expected payoff for equity holders?
If Zymase has debt of $30 million due at the time of the project's payoff; the project with the highest expected payoff for equity holders is: (Select the best choice below.)
A. Project A
B. Project B
c. Project C
c. Suppose Zymase has debt ofS110 million due at the time of the project's payoff. Which project has the highest expected payoff for equity holders?
If Zymase has debt of S110 million due at the time of the project's payoff, the project with the highest expected payoff for equity holders is: (Select the best choice below.)
A. Project A
B. Project B
C. Project C
d. If management chooses the strategy that maximizes the payoff to equity holders, what is the expected agency cost to the firm from having S30 million in debt due? What is the expected agency cost to the firm from having Sl10 million in debt due?
If management chooses the strategy that maximizes the payoff to equity holders, the expected agency cost to the firm from having s3o million in debt due is $__ million. (Round to the
nearest integer.)
The expected agency cost to the firm from having S110 million in debt due is $__ million. (Round to the nearest integer.)
Strategy
Probability
Payoff
($million)
A
100%
75
B
50%
130
50%
0
c
10%
310
90%
30
Explanation / Answer
a.) Which Project has highest payoff
Project A Payoff= $75 million
Project B Payoff= 50%*$130 + 50%*0= $75 million
Project C Payoff= 10%*$310+ 90%*$30 = $58 million
So Projects A & B have highest payoffs.
b. Suppose Zymase has debt of $30 million due at the time of the project's payoff. Which project has the highest expected payoff for equity holders?
In case of debt of $30 million, the management has to payoff this amount before paying the equity holders so the management will prefer a strategy which guarantees the payment of debt i.e. Project A
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?
As the debt of management is higher than expected payoffs of each project it will prefer a strategy which max. possibility of debt payoff so that equity holders are able to have some payoff at the end.
So it will go with Project B as it has 50% chance of payoff of $130 million i.e. equity holders have 50% chance of payoff of $20 million after debt is cleared.
d. If management chooses the strategy that maximizes the payoff to equity holders, what is the expected agency cost to the firm from having $30 million in debt due? What is the expected agency cost to the firm from having $110 million in debt due?
Expected Agency Cost in Case B will be zero as company will be definitely paying off the debt so zero. However if it decides to ignore debt owners and tries to maximise the payoff to equity holders it will go with Project C which will lead to Agency cost of 90%*$30 = $27 million
Expected Agency Cost in Case C will be 50%*110 million = $55 million.
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