Question
(a) Sixzung Group has promised payments to its bondholders that total $3,000 one year from today. The company believes that there is a 65% chance
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(a) Sixzung Group has promised payments to its bondholders that total $3,000 one year from today. The company believes that there is a 65% chance that the cash flow will be just sufficient to meet these claims. However, there is a 35% chance cash flows will fall short, in which case total earnings are expected to be $2,000. If bondholders estimate the bankruptcy costs to be $350, what should be the bond price in the market? Assume a cost of debt of 15%.
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(b) Sixzung Group considers a risky investment project. If it takes it, there will be 10% chance that the total cash flow one year later will become $5,000 and 90% chance of failure with no cash remains.
(i) Analyze from the shareholders point of view if they prefer accepting that risky investment project by referring to the present value of stocks with and without the project. Assume the required return of shareholders is 45%.
(ii) Evaluate if bondholders will be better off or worse off if the risky project is accepted.
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