New project can only be financed with new equity issue

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Reference no: EM132069661

A firm has debt with a face value of $100. Its projects will pay a safe $80 tomorrow. Managers care only about shareholders. A new quickie project comes along that costs $30, earns either $0 or $70 with equal probabilities, and does so by tomorrow. Assume that the time value of money is 0

1. Is this a positive-NPV project?

2. If the new project can only be financed with a new equity issue, would the shareholders vote for this? Would the creditors?

3. Assume the existing bond contract was written in a way that allows the new projects to be financed with first collateral (superseniority with respect to the existing creditors). New creditors can collect $30 from what the existing projects will surely pay. Would the existing creditors be better off?

4. What is the better arrangement from a firm-value perspective if the old bondholders have veto power.

Reference no: EM132069661

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