I didnt know the answers to the multiple choice
Petron Carporatian's management team is meeting to decide on a new cargorate strategy. There are four options, cach with a different probability of success and total firm value in the event of success, as shown here: B. Assume that for each strategy firm value is zera in the event of falure. Also, suppose Petron Corp. has debt with a face value of $42 million outstanding. For simplicity assume all risk is idiosyncretic, the risk-free interest rate la zero, and there are no tenes. a. What is the expected value of equity, assuming Petron will choose the strategy that modtzes the value of its equity? What is the total expected value of the firm? b. Suppose Petran issues cquity and buys hack its neht, reducing the reht's face value to S4 million. If it does so, which strategy will it choose after the transaction? Wil the total value of the firm increase? c. Suppose you are a debe holder, deciding whether to sel your debe back to the fire. If you expect the firm to reduce its debt to milion, what price would you derrand to sell your debt? d. Based on your answer to ic), how much will Petron need to raise from equity holders in order to buy back the debt? e. How much wil equity holders gain or lose by recepitalizing to reduce leverage? How much wil debt holders gain or lose? Would you expect Petron's management to choose to reduce Me leverage? a. What is the expected value of equily, aecurring Pelren will choose the stralegy that maximizes the value of its equity? What is the local expected value of the firen? Calculate the equity values below milions) (Round to one decimal place.) Strategy A D Equity Value S $ $ The expected value of the firsnis million (Round to are deciral place.) wth S42 millon tece value of debt, the firm will choose strategy input ther A.B.C.D.) b. Suppose Petron issues equity and buys back its debt, reducing tett's face value to S4 milion. If it does so, which strategy will it choose aller the transaction? Wil the total value of the firm increase? Calculate the equity values below milions): (Round to one decimal place.) Strategy B D Equity Value $ $ $ With S4 milion in debt outstanding, management will choose strategy. (Input either A, B, C, D.) c. Suppose you are a debt holder, deciding whether to sel your debt back to the firm. If you expect the firm to reduce its debt to milion, what price would you demand to sell your debt? (Select the best choice below. O A. Price will be at a discount OB. Price will be al apreinium OC. Price will be fisce value OD. None of the above A. Price will be at a discount. Data Table - B. Price will be at a premium. C. Price will be face value. (Click on the following icon in order to copy its contents into a spreadsheet.) D. None of the above. d. Based on your answer to (c), how much will Petron need to raise from equity holders in order to buy back the debt? (Select the best choice A D Strategy B C 84% 68% 59 69 100% Probability of Success Firm Value if Successful (in $ million) 52% 79 49 A. Petron will need to raise $21 million from equity holders (as the debt is risk-free and has a face value of $21 million). B. Petron will need to raise $42 million from equity holders (as the debt is risk-free and has a face value of $42 million). C. Petron will need to raise $4 million from equity holders (as the debt is risk-free and has a face value of $4 million). D. will need to raise $38 million from equity holders (as the debt is risk-free ar ha a face value $38 million). Print Done e. How much will equity holders gain or lose by recapitalizing to reduce leverage? How much will debt holders gain or lose? Would you expect Petron's management to choose to reduce its leverage? (Select the best choice below.) A. The expected value of equity after the transaction is $46.2 million, but equity holders had to contribute $38 million to buy back the debt. Thus, the net expected payoff to equity holders is $8.2 million. If they had not done the buyback, equity would have been worth $19.2 million. Thus, equity holders lost $11.0 million as a result of the buyback. B. Even though the total value of the firm increases by $11.0 million by reducing leverage and eliminating agency costs, the debt holders capture more than $11.0 million, and thus equity holders lose. Therefore, even though Petron has an inefficiently high level of leverage, the ratchet effect of debt overhang implies that it will not choose to reduce its leverage. C. Debt holders received $38 million, and still hold $4 million in risk-free debt, for a total payoff of $42 million after the buyback. Had Petron not done the buyback, the debt would have been worth 52% $42 million = $21.8 million. Thus, debt holders gained $20.2 million as a result of the buyback. D. All of the above. Petron Carporatian's management team is meeting to decide on a new cargorate strategy. There are four options, cach with a different probability of success and total firm value in the event of success, as shown here: B. Assume that for each strategy firm value is zera in the event of falure. Also, suppose Petron Corp. has debt with a face value of $42 million outstanding. For simplicity assume all risk is idiosyncretic, the risk-free interest rate la zero, and there are no tenes. a. What is the expected value of equity, assuming Petron will choose the strategy that modtzes the value of its equity? What is the total expected value of the firm? b. Suppose Petran issues cquity and buys hack its neht, reducing the reht's face value to S4 million. If it does so, which strategy will it choose after the transaction? Wil the total value of the firm increase? c. Suppose you are a debe holder, deciding whether to sel your debe back to the fire. If you expect the firm to reduce its debt to milion, what price would you derrand to sell your debt? d. Based on your answer to ic), how much will Petron need to raise from equity holders in order to buy back the debt? e. How much wil equity holders gain or lose by recepitalizing to reduce leverage? How much wil debt holders gain or lose? Would you expect Petron's management to choose to reduce Me leverage? a. What is the expected value of equily, aecurring Pelren will choose the stralegy that maximizes the value of its equity? What is the local expected value of the firen? Calculate the equity values below milions) (Round to one decimal place.) Strategy A D Equity Value S $ $ The expected value of the firsnis million (Round to are deciral place.) wth S42 millon tece value of debt, the firm will choose strategy input ther A.B.C.D.) b. Suppose Petron issues equity and buys back its debt, reducing tett's face value to S4 milion. If it does so, which strategy will it choose aller the transaction? Wil the total value of the firm increase? Calculate the equity values below milions): (Round to one decimal place.) Strategy B D Equity Value $ $ $ With S4 milion in debt outstanding, management will choose strategy. (Input either A, B, C, D.) c. Suppose you are a debt holder, deciding whether to sel your debt back to the firm. If you expect the firm to reduce its debt to milion, what price would you demand to sell your debt? (Select the best choice below. O A. Price will be at a discount OB. Price will be al apreinium OC. Price will be fisce value OD. None of the above A. Price will be at a discount. Data Table - B. Price will be at a premium. C. Price will be face value. (Click on the following icon in order to copy its contents into a spreadsheet.) D. None of the above. d. Based on your answer to (c), how much will Petron need to raise from equity holders in order to buy back the debt? (Select the best choice A D Strategy B C 84% 68% 59 69 100% Probability of Success Firm Value if Successful (in $ million) 52% 79 49 A. Petron will need to raise $21 million from equity holders (as the debt is risk-free and has a face value of $21 million). B. Petron will need to raise $42 million from equity holders (as the debt is risk-free and has a face value of $42 million). C. Petron will need to raise $4 million from equity holders (as the debt is risk-free and has a face value of $4 million). D. will need to raise $38 million from equity holders (as the debt is risk-free ar ha a face value $38 million). Print Done e. How much will equity holders gain or lose by recapitalizing to reduce leverage? How much will debt holders gain or lose? Would you expect Petron's management to choose to reduce its leverage? (Select the best choice below.) A. The expected value of equity after the transaction is $46.2 million, but equity holders had to contribute $38 million to buy back the debt. Thus, the net expected payoff to equity holders is $8.2 million. If they had not done the buyback, equity would have been worth $19.2 million. Thus, equity holders lost $11.0 million as a result of the buyback. B. Even though the total value of the firm increases by $11.0 million by reducing leverage and eliminating agency costs, the debt holders capture more than $11.0 million, and thus equity holders lose. Therefore, even though Petron has an inefficiently high level of leverage, the ratchet effect of debt overhang implies that it will not choose to reduce its leverage. C. Debt holders received $38 million, and still hold $4 million in risk-free debt, for a total payoff of $42 million after the buyback. Had Petron not done the buyback, the debt would have been worth 52% $42 million = $21.8 million. Thus, debt holders gained $20.2 million as a result of the buyback. D. All of the above
