In a world that is not perfect but risk neutral, assume that the firm has projects worth $100 in the down-state, $500 in the up-state. The cost of capital for projects is 25%. However, if you could finance it with 50-50 debt, the cash flow rights alone are enough to make the cost of a capital a lower 20%. Managers are intransigent and do not want to switch to this new capital structure. You only have $60 of capital and cannot borrow more to take over the firm. What can you do?
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