#3. A firm has a senior bond obligation of $20 due this period and $100 due next...
Question:
#3. A firm has a senior bond obligation of $20 due this period
and $100 due next period.
It also has a subordinated loan of $40 owed to Jack and Jill an
d due next period. It has no
projects that provide cash flows
this period. Therefore, if th
e firm cannot get a new loan
for $20, it must liquidate. The firm has a current liquidation
value of $120. If the firm
does not liquidate, it can take on one of two projects with no
additional investment funding
needed. If it takes project A, the project will generate a cas
h flow of $135 next year for
sure. If it takes project B, the project will generate a cash
flow next year of $161 or $69
with equal probability. Assume risk-neutrality, a zero interes
t rate, no direct bankruptcy
costs, and no taxes.
(a)
If the firm were entirely equ
ity financed, woul
d it decide to l
iquidate, adop
t project A,
or adopt project B?
(b)
The firm has approached Jack and Jill and asked them for a $20
(subordinated) loan.
The $20 loan proceeds will be used to pay off the $20 of senior
debt that is currently due.
The firm promises to pay Jack and Jill back $20.5 next period o
n this new loan plus the
$40 on the original loan. If Jack and Jill agree to the loan,
which project will be taken by
the firm? Should Jack and Jill agree to the loan? Justify you
r answer with the relevant
calculations.
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Introduction To Health Care Management
ISBN: 9781284081015
3rd Edition
Authors: Sharon B. Buchbinder, Nancy H. Shanks