Answer 1)

Given value of the company in different scenarios,

Economic Growth Probability Without Expansion
Low
.30
$20,000,000
$24,000,000
Normal
.50
$34,000,000
$45,000,000
High
.20
$41,000,000
$53,000,000

With Expansion

Expected value of the company without expansion =

E(value of company) = P(Low)*V(Low) + P(Normal)*V(Normal) + P(High)*V(High)
= .30*20,000,000 + .50*34,000,000 + .20*41000,000
= $31,200,000 = $31.2 million
Expected value with expansion =
E(value of company) = P(Low)*V(Low) + P(Normal)*V(Normal) + P(High)*V(High)
=0.3*24+0.5*45+0.2*53= $40.3 million
Answer 2)
Companys debt is $25 million.
Expected value of debt without expansion = .30*25 + .50*25 + .20*25 = $25 million
Since companys expansion plan is fully funded by equity, debt does not change and
expected value of debt with expansion will remain same i.e. $25 million
Answer 3)
Expected value of company without expansion =$31.2 million
Expected value of company with expansion =$ 40.3 million
Change in expected Value of company due to expansion = 40.3-31.2= $9.1 million
Equity of $9 million was required to fund the expansion.
So, Net Value created by expansion = 9.1 million - 9 million = $0.1 million
Since expansion was entirely financed by equity, there is no change in the level of debt.
So, Expected value for stockholder = $0.1 million
Expected value for bondholders = $0
Answer 4)
Case-1: Company does not expand:
There would be no change to the status of the bondholders (as debt of $25 million
remains). So, there will not be any change in the value of the bonds.
Case-2: Company expands:
If the company expands, expected value of equity holders will increase. So, value of
equity will also increase. This will decrease debt-equity ratio. Result is, long term
solvency risk of the company will decrease.
This will result in low cost of debt, which can be reflected by increased price of bond (as
value of bond will go up.).

Answer 5)
If company decides to not to expand, there is no need to raise fresh capital in any form
(debt or equity). So, no borrowing is required.
Even if company decides to expand, it can not raise debt as the company is under
obligation not to raise any further debt until next year. Hence, it has to finance the entire
expansion through equity only. Thus, the equity base of the company will increase. After
one year, if need arises, company can raise debt too if it decides to expand.
Answer 6)
If company could finance its expansion through cash, no fresh equity were required. So,
the cost of fund would be lower. It would make the expansion more attractive . Saving
would happen as company could save the floating cost (of equity).