In a highly leveraged firm, why is it better for stockholders if the firm picks a project with lower NPV and higher volatility?
The idea is that if a highly leveraged firm can choose between a project with a lower NPV and a higher volatility and a project with a higher NPV and a lower volatility, it would benefit the stockholders if the project with the lower NPV is chosen. Why is this the case?
Is it because in high leverage situations, equity derives most of its value from option value? Higher volatility boosts option price as per Black-Scholes.
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