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)
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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