1. You own the loan to a firm with face amount of $160 million due in one year. The firm will just last the one year generating cash flows of $200 million and $100 million with probabilities of 0.75 and 0.25, respectively. A new project is available that requires an investment of $36 million and pays off a certain $44 million in one year. Unfortunately, the firm has no cash and needs to seek outside capital. Assume the manager is currently the sole shareholder and your debt is protected with a pari passu covenant and so debt is not allowed to be issued senior to you without permission.

1. Do you expect the manager to undertake the project? Assume that he issues Junior Debt for the capital needed for the project; and, determine the face value of that Junior Debt to demonstrate the payoffs to all investors (9 points)

2. A financial advisor is pushing for the firm to enter Chapter 11 where he has already lined up DIP financing for the $36 million. For you to take this path, though, 10% of the shares will be given to the advisor for his compensation in arranging the deal. If this were to take place, would this be something you would fight or consider? That is, are you better off with this plan and if so by how much? Explain. (5 points)

3. You are not happy about the financial advisors costs, so you offer to provide the $36 million yourself for the equivalent of the DIP financing. To simplify, you offer the $36 million for another $40 million in Senior debt (the equivalent of your debt now having a face value of $200 million). Is either party better or worse off if you agree to this? Demonstrate by how much and explain. Does this split the surplus evenly? (5 points)

4. The manager suggests that you take on the same amount of face value as the original DIP plan put forth by the financial advisor ($36 million). You ask for a share of the equity then so that the two of you are splitting the surplus half each. What fractional share of the equity would you need to split the surplus evenly? (3 points)