A financially distressed firm has existing assets that will be worth $70 million in one year. The firm owes debtholders $100 million in one year. The firm has an opportunity to undertake a new project that requires shareholders to invest $25 million today, produces a certain payoff of $40 million in one year, and has a discount rate of 0%. Managers act in the best interests of shareholders. Will shareholders finance the project, and what is the agency cost caused by debt overhang? (Hint: agency costs are defined as the loss in firm value due to distortions in management incentives.)Single choice

A

Shareholders will not invest; agency cost is $25 million.

B

Shareholders will invest; agency cost is $0 million.

C

Shareholders will not invest; agency cost is $15 million.

D

Shareholders will not invest; agency cost is $40 million.

E

Shareholders will invest; agency cost is $15 million.

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