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FinanceQ&A LibraryCompany ABC just sold their most profitable division for $100 million in cash. The company has a market value balance sheet shown below (in millions). The bonds outstanding have an annual payment that is due in one month that equals 10% of the book value (400 x .10 = $40 million). Note: If the payment is not made on time it accrues a penalty of 1% or $400,000 per month unpaid: Assets BV MV Liabilities BV MV Cash $100 $100 LT bonds $400 $100 Fixed Asset $900 $0 Equity $600 $0 Total $1,000 $100 Total $600 $100 The board is considering using the $100 million to sponsor a music festival that might be a success or a failure. The expected payoffs are as follows: Probability Payoff 5% $500 25% $200 50% $50 20% $0 B) Instead of the music festival, the company has the opportunity to participate in a government sponsored program that guarantees a return of 10%. This program requires minimum participation of $200 million that is paid in cash and the discount rate is 5%. (i) If the company issues $100 million in new equity to fund the obligation, what are the expected market values on the balance sheet (ignore the interest payment on the debt) (ii) The company issues $100 million in debt at an interest rate of 20% to fund the opportunity, does this help the stockholders position? (Note: consider all the amounts due the debtholders)Start your trial now! First week only $4.99!*arrow_forward*

Question

Company ABC just sold their most profitable division for $100 million in cash. The company has a market value balance sheet shown below (in millions). The bonds outstanding have an annual payment that is due in one month that equals 10% of the book value (400 x .10 = $40 million). Note: If the payment is not made on time it accrues a penalty of 1% or $400,000 per month unpaid:

Assets BV MV Liabilities BV MV

Cash $100 $100 LT bonds $400 $100

Fixed Asset $900 $0 Equity $600 $0

Total $1,000 $100 Total $600 $100

The board is considering using the $100 million to sponsor a music festival that might be a success or a failure. The expected payoffs are as follows:

Probability Payoff

5% $500

25% $200

50% $50

20% $0

B)

Instead of the music festival, the company has the opportunity to participate in a government sponsored program that guarantees a return of 10%. This program requires minimum participation of $200 million that is paid in cash and the discount rate is 5%.

(i) If the company issues $100 million in new equity to fund the obligation, what are the expected market values on the balance sheet (ignore the interest payment on the debt)

(ii) The company issues $100 million in debt at an interest rate of 20% to fund the opportunity, does this help the stockholders position? (Note: consider all the amounts due the debtholders)

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