Question

Assume that instead, the debtholders had negotiated a covenant based on the maximum amount of investment (so, they set a maximum on the amount of investment, such as the $500in project costs). Assume that the probabilities and returns are proportionate (so, 40%probability that you double your money, and 60% chance that you lose your investment). What is the maximum amount of investment into this type of project that would allow shareholder and debtholder incentives to be aligned (should be less than $500 in this instance)?

Answer 1

Answer:

if we assume that the maximum investment must reach $ 500 Then the maximum that the shareholder should invest with $ 500  to not exceed the investment covenant, considering that these $ 500 have a 40% chance to earn $200. debtors should always consider the maximum amounts required in financial covenants.

E