The firm just restructured its debt at no additional cost so that all the

liabilities are in the form of a single bond maturing in exactly 5 years. This was done in such

a manner that the new debt was just enough to retire all current liabilities and the former

long term debt. That is, your Balance Sheet contains only Owner's Equity and Long Term

Debt. The current estimate is that the Market Value of the firm is $29.75MM and that its

standard deviation is roughly 23%.

(a) What are the Market Values of Equity and Debt? Use the same risk free rate as in

question 3 (d).

In light of the debt restructuring, one of the largest shareholders in the company asked

to speak to you and the CEO to discuss a few opportunities she sees in the market that

could benet all the company stakeholders. The investor asked for your help regarding two

mutually exclusive investments of $5MM that would be nanced exclusively with a bond

with similar terms to the outstanding long term debt. The cost of issuing such bond is

estimated at 5% of the notional value and it is expected to raise exactly the $5MM needed.

The cash ows generated by both investments have present values of $7.5MM.

(b) The rst investment proposed is such that it will consolidate operations and make the

company less risky. The new estimated standard deviation of assets is around 18%.

What are the new Market Values of Equity and Debt under this investment?

(c) The second investment opportunity makes the company substantially riskier; the new

estimated standard deviation of assets is 75%. What are the new Market Values of

Equity and Debt under this investment?

(d) Comment on the results obtained in (b) and (c). Namely, is it the case that all

stakeholders will benet if the rm engages in one of the investments above?

Market-to-Book Ratio 1.25

Income Statement 2015 $43,000,000 Taxes: Sales 40% $30,000,000 COGS Shares outstanding 1,000,000 $5,000,000 Other expenses Depreciation $2,000,000 $6,000,000 EBIT $2,000,000 nterest $4,000,000 Taxable income Taxes (40%) $1,600,000 Net income $2,400,000 Dividends $600,000 Add to RE $1,800,000 Balance Sheet, Dec 31, 2015 Liabilities & Owners' Equity Assets Current Assets Current Liabilities ash $500,000 Accounts Payable $1,000,000 Notes Payable $3,000,000 Accounts Receivable $1,000,000 Inventory $2,000,000 Total CL $4,000,000 Total CA Long Term Debt $10,000,000 $3,500,000 Fixed Assets Owners' Equity Common Stock $6,500,000 Net PP&E $25,000,000 Retained Earnings $8.000,000 Total Equity $141500,000 Total L & O $28.500.000 Total Assets $28.500.000 Income Statement 2015 $43,000,000 Taxes: Sales 40% $30,000,000 COGS Shares outstanding 1,000,000 $5,000,000 Other expenses Depreciation $2,000,000 $6,000,000 EBIT $2,000,000 nterest $4,000,000 Taxable income Taxes (40%) $1,600,000 Net income $2,400,000 Dividends $600,000 Add to RE $1,800,000 Balance Sheet, Dec 31, 2015 Liabilities & Owners' Equity Assets Current Assets Current Liabilities ash $500,000 Accounts Payable $1,000,000 Notes Payable $3,000,000 Accounts Receivable $1,000,000 Inventory $2,000,000 Total CL $4,000,000 Total CA Long Term Debt $10,000,000 $3,500,000 Fixed Assets Owners' Equity Common Stock $6,500,000 Net PP&E $25,000,000 Retained Earnings $8.000,000 Total Equity $141500,000 Total L & O $28.500.000 Total Assets $28.500.000