# 7. The value of the HILEV firm at the end of one year can be $50 m

or $100 m with an equal probability of 0.5. The firm has debt with a face value of $50 m that matures in one year. Assume that investors are risk-neutral, and the risk-free rate is zero. The CEO of the firm decides to substitute assets of the firm with more risky assets immediately so that the value of the firm at the end of one year is either $30 m or $120 m with an equal probability of 0.5. This asset substitution leads to _____________________. [Reference: [Mod 4, Capital Structure - Distress costs mini-lecture]

A. a gain of $10 million for stockholders and a loss of $10 million for bondholders

B. a loss of $10 million for stockholders and a gain of $10 million for bondholders

C. no gain or loss to debtholders or equity holders

D. both debtholders and equity holders lose $10 million

8. Which of the following happens when a distressed firm issues debt senior to the existing debt? [Reference: Mod 4, Capital Structure - Distress costs mini-lecture]

A. Claim dilution

B. Asset substitution

C. Underinvestment

D. Adverse selection

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