. Emruss Industries has no cash flow this year, but it expects to have a cash flow of $1.5 million next year if the firm is able to lower its costs, and a cash flow of $.5 million next year if the firm is unable to lower its costs. There is a .5 probability that the firm will be able to lower its costs next year, and a .5 probability that they will be unable to lower their costs. The firm can be liquidated immediately for $1.2 million. The firm has both junior debt and senior debt outstanding. For simplicity, assume that future cash flows are not discounted (i.e. assume that the appropriate discount rate is 0%).

Due immediately Due next year

Senior debt $150,000 $1,000,000

Junior debt $0 $200,000

If Emruss does not pay the $150,000 due immediately, it will be forced into liquidation (i.e. Chapter 7). If APR is followed in liquidation, how much will the junior debtholders receive in liquidation?

Suppose the management of Emruss asks the junior debtholders for $150,000 in exchange for a new junior bond that promises repayment of $250,000 in one year. The old junior bond will remain outstanding (i.e., it will not be canceled). Will the junior debtholders agree to this deal? Will Emruss management be willing to offer this deal? Will the senior debtholders be happy if the junior debtholders accept this offer?