You are an analyst at an Investment Bank hired by a group of creditors to evaluate the proposal given by the borrowers to your customers. These creditors only hold senior debt of the firm. Here are the details of the proposal:

XYZ Corporation is the borrower and has total assets worth $89MM today. Research has shown that the standard deviation of the rate of return on these assets is 50% (0.5) per year. XYZ issued a series of one and a half year zero-coupon bonds with total face value of $90MM. Of the total bond issue, senior debt accounted for $40MM in face value while $50MM in face value of the bonds are junior debt. The firm has 100,000 shares of stock outstanding. In one year, XYZ is expected to issue a riskless dividend of $50 per share to its equity holders. The risk-free interest rate is currently 9% per year.

Find out the value of the senior debt, junior debt, and equity of the firm.

Proposal 1: Under the terms of the bond issuance, XYZ is prohibited from undertaking any major projects/investments that will significantly impact the companys operations, capital structure, and risk profile in an impactful manner. The management of XYZ Corporation has identified a business opportunity that will require a significant investment of resources that they can finance internally with cash and cash flow from operations. The company forecasts that if this investment works out, it will yield significant returns. The company is asking its creditors to waive the debt covenant that prohibits them from undertaking such an investment. The creditors inquired as to how this affects the risk profile of the company. In response, the company says it will increase the standard deviation of the returns on its firms assets from 50% to 60% but this increased risk is worth it since it will yield significantly higher returns and free cash flow going forward putting them in better position to pay its debt obligations.

Proposal 2: XYZ Corporation also came up with an alternative proposal to its first proposal in case the creditors reject the first proposal. In order to free up cash and not trip/violate any covenants, XYZ Corporation proposed to suspend paying its dividends. In exchange, it is asking its creditors to extend the term of the bond from one and a half years to two years.

Questions:

1. As advisor to the senior debt holders, do you think they should approve proposal 1 or 2? The proposals are an either/or proposition, only one of the proposals will be undertaken so evaluate both separately and independently of each other.
2. Why should or why shouldnt the senior creditors approve either proposal?
3. What is the economic impact of each proposal to the senior creditors?
4. Can you quantify how much the changes that XYZ Corporation requesting are worth?
5. As an advisor, can you come up with counter-proposals that the senior creditors can forward to XYZ Corporation?