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Prohibit the issuance of senior debt

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Reference no: EM132473805

H Limited has risky assets-in-place with possible values next year presented below:

  • H has a one-year safe project that requires investment outlay of $15 million today and will generate $22 million next year. 
  • In addition, H has $15M in cash. This money can be either paid out as a dividend or invested.
  • Currently, H has $35 million debt in its capital structure due next year.  
  • The risk-free rate is 10%.

(a) Will H's shareholders fund the project? Explain.

(b) Will H's shareholders fund the project by issuing new junior debt? Explain.

(c) Will H's shareholders fund the project by issuing debt of same seniority? Explain.

(d) How about senior debt if the existing debt covenant doesn't prohibit the issuance of senior debt? Explain.

Parts (b), (c) and (d) require some simple calculation and numerical justification. Please show your supporting work.

Reference no: EM132473805

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