Construct the balance sheet

Reference no: EM132806979

Question - Consider a firm with assets in place that generate 200 in state H with probability 50% and 0 in state L also with probability 50%. The assets of the firm are financed with equity and zero-coupon debt with face value 80.

a) Construct the balance sheet.

(b) The manager discovers a project that costs 50 and generates 60 in both states. The manager considers issuing new shares to finance the project. Will he do it? Construct the balance sheet with the project and equity financing.

(c) The manager also considers taking up a new loan, which is junior to existing debt. How much face value does the firm need to issue to cover the investment cost?

(d) Will the manager take up a new loan to finance the project? Construct the balance sheet with the project and junior debt financing.

(e) Yet a third alternative is to ask old debtholders to reduce their claim before issuing new junior debt. How much face value are old shareholders willing to give up? Assume that the firm and old debt holders have equal bargaining power and willing to split the difference in half.

Reference no: EM132806979

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