Question $4$

The company recently reorganized its debt structure at no extra expense, consolidating all liabilities into a single bond maturing in precisely $5$ years. This strategic

move involved issuing new debt in an amount sufficient to retire all existing current liabilities and the long$-$term debt. Consequently, your Balance Sheet now solely

consists of Owner's Equity and Long Term Debt. Present estimates suggest that the Market Value of the firm's assets stands at $$40$ million, with an approximate

standard deviation of $23\%.$

a$.$ What are the Market Value numbers for the Equity and Debt? Use the same risk free rate assumption as in question $3($d$).$

Following the debt restructuring, one of the company's major shareholders has requested a meeting with you and the CEO to explore several opportunities she

believes could benefit all company stakeholders. The investor seeks your assistance regarding two mutually exclusive investments, each requiring $$5$ million in

financing, exclusively funded by a bond with terms similar to the existing long$-$term debt. The estimated cost of issuing this bond is $5\%$ of the notional value, and we

expect the bond to precisely cover the $$5$ million requirement. Both investments are projected to generate cash flows with present values of $$7\mathrm{.}5$ million.

b$.$ The first investment proposal aims to consolidate operations, thereby reducing the company's overall risk. As a result, the newly estimated standard

deviation of assets is approximately $18\%.$ What would be the revised Market Values of Equity and Debt following this investment?

c$.$ The second investment opportunity involves introducing a new product, significantly increasing the company's risk profile. With this, the newly estimated

standard deviation of assets rises to $75\%.$ What would be the updated Market Values of Equity and Debt considering this investment?

d$.$ Provide an analysis of the findings from $($b$)$ and $($c$).$ Specifically, consider whether engaging in either of the investments would result in benefits for all

stakeholders involved.