Would the insurance company benefit from the proposal

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Reference no: EM132753141

Question - Management proposes a plan to lower the interest burden for a company called DLO. DLO has one debt investor, an insurance company. This insurance company also holds a fraction of DLO's equity. The proposal to the insurance company is to lower the coupon payments of the existing debt contract from $12 million perpetual annual coupon payments to $9 million perpetual annual coupon payments. Under the proposal, DLO would not make any additional payments to the insurance company to compensate for the lower coupon payments. The next coupon payment is due in one year from today, independent of whether the proposal is accepted or not. There is no risk of default in either case, and there is no inflation. If the proposal is accepted, it will not have any effects on DLO's unlevered free cash flows or on its expected return on unlevered assets. Assume that the assumptions of the CAPM are satisfied. The market risk premium is 7%. The average debt beta of firms that are in the same industry is 0.3, but there are large differences in leverage across firms in the industry. The risk-free rate is constant and equal to 1%. The corporate tax rate is 25%. You can assume that DLO will be profitable independent of whether the proposal is implemented.

Be sure to answer all of the parts of the question and clearly label your answer for each part. For example, begin your answer to part A with 'Part A:'

A. What would be the change in DLO's total firm value, if the insurance company accepted the proposal?

B. What would be the change in DLO's overall equity value, if the insurance company accepted the proposal?

C. If the insurance company not only owns all of DLO's debt but also 50% of DLO's equity, would the insurance company benefit from the proposal?

Reference no: EM132753141

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