Reference no: EM132994718

A company has no cash flow this year. The company will have a cash flow of $3 million next year if it is able to lower its costs and $1 million next year if it is unable to lower its costs. The company will generate no cash flows after next year. There is a 50% probability that the company will be able to lower its costs and a 50% probability that it will be unable to lower its costs. The company can be liquidated immediately for $2.4 million. If the company is not liquidated immediately, its assets have no future liquidation value. The company has both junior debt and senior debt outstanding. $300,000 of its senior debt is due immediately. If the company does not pay the $300,000 due immediately, it will be forced into liquidation, and the liquidation proceeds will be distributed according to the APR. Assume that there is no discounting, taxation, or direct cost of bankruptcy.

The company's debt obligations are as follows:

                                       Due immediately            Due next year
Senior debt                         $300,000                 $2,000,000
Junior debt                             $0                        $400,000

Suppose the company's management asks the junior creditors for $300,000 of cash in exchange for an additional junior bond that promises repayment of $500,000 in one year. The $300,000 proceeds from this transaction will be used to pay the senior debt that is due immediately.

Problem a) Will the junior creditors agree to this offer?

Problem b) Will the company's management be willing to offer this offer (assuming that they maximize shareholder value)?

Problem c) Will the senior creditors be happy if the junior creditors accept this offer?