Suppose Tefco Corp. has a value of $131 million if it continues to operate, but has outstanding debt of $160 million that is now due. If the firm declares bankruptcy, bankruptcy costs will equal $22 million, and the remaining $109 million will go to creditors. Instead of declaring bankruptcy, management proposes to exchange the firm's debt for a fraction of its equity in a workout. What is the minimum fraction of the firm's equity that management would need to offer to creditors for the workout to be successful?

Suppose Tefco Corp. has a value of $131 million if it continues to operate, but has outstanding debt of $160 million that is now due. If the firm declares bankruptcy, bankruptcy costs will equal $22 million, and the remaining $109 million will go to creditors. Instead of declaring bankruptcy, management proposes to exchange the firm's debt for a fraction of its equity in a workout. What is the minimum fraction of the firm's equity that management would need to offer to creditors for the workout to be successful?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter7: Analysis Of Financial Statements

Section: Chapter Questions

Problem 10P: The Morrit Corporation has $600,000 of debt outstanding, and it pays an interest rate of 8%...

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Suppose Tefco Corp. has a value of $154 million if it continues to operate, but has outstanding debt of $176 million that is now due. If the firm declares bankruptcy, bankruptcy costs will equal $21 million, and the remaining $133 million will go to creditors. Instead of declaring bankruptcy, management proposes to exchange the firm's debt for a fraction of its equity in a workout. What is the minimum fraction of the firm's equity that management would need to offer to creditors for the workout to be successful? Tefco could offer its creditors % of the firm in a workout. (Round to one decimal place.)
Suppose a company borrows $1 million debt to invest in a project that generates uncertain future cash flow (revenue) of o*$2 million (when debt is due). The debt has to be repaid (interest rate is zero) when the project's cash flow is realized. Assume 46% of the cash flow (revenue) is lost upon bankruptcy (i.e., when debtholders control the firm). Also, assume that renegotiations are allowed and the manager may be allowed to stay if debtholders find it better than firing. Upon renegotiation debt and equity holders have equal bargaining power. At what company cash flow does strategic default start to occur? 1.0 million 1.3 million 2.0 million 1.6 million
Suppose a company borrows $1 million debt to invest in a project that generates uncertain future cash flow (revenue) of 0~$2 million (when debt is due). The debt has to be repaid (interest rate is zero) when the project's cash flow is realized. Assume 46% of the cash flow (revenue) is lost upon bankruptcy (i.e., when debtholders control the firm). Also, assume that renegotiations are allowed and the manager may be allowed to stay if debtholders find it better than firing. Instead of equal bargaining power, if borrower has full bargaining power (borrower gets 100% of renegotiation), at what company cash flow does strategic default start to occur? 1.46 million 1.0 million 1.97 million 1.85 million
Suppose a company borrows $1 million debt to invest in a project that generates uncertain future cash flow (revenue) of 0~$2 million (when debt is due). The debt has to be repaid (interest rate is zero) when the project's cash flow is realized. Assume 20% of the cash flow (revenue) is lost upon bankruptcy (i.e., when debtholders control the firm). Also, assume that renegotiations are allowed and the manager may be allowed to stay if debtholders find it better than firing. Instead of equal bargaining power, if lender has 30% bargaining power (lender gets 60% of renegotiation), at what company cash flow does strategic default start to occur? 1.16 million 1.25 million 1.65 million 0.85 million
The manager of a firm at t=0 has to decide whether to liquidate or to continue. If he decides to continue in t=1, the value of the firm assets will be Va= €140 million assuming business recovers. Nevertheless, the most likely scenario ((1-p) = 85%) is that the company sales will continue declining. Then, company assets will be valued only at Vẞ = €78 million. At what debt value, we see an inefficiency case because Managers' Aversion to Liquidation. a. $60 million O b. None * C. $100 million d. $80 million Your answer is incorrect. The correct answer is: $100 million
Suppose a company borrows $1 million debt to'invest in a project that generates uncertain future cash flow (revenue) of 0-$2 million (when debt is due). The debt has to be repaid (interest rate is zero) when the project's cash flow is realized. Assume 35% of the cash flow (revenue) is lost upon bankruptcy (i.e., when debtholders control the firm). Also, assume that renegotiations are allowed and the manager may be allowed to stay if debtholders find it better than firing. Instead of equal bargaining power, if lender has 25% bargaining power (lender gets 25% of renegotiation), at what company cash flow does strategic default start to occur? 1.16 million O 0.85 million 1.36 million O1.65 million
Horizon Corporation has decided to a capital restructuring. This process of restructuring involves increasing its existing $80 million in debt to $125 million. However, the interest rate on the debt is 9 percent and it is not expected to change. The firm currently has 10 million shares outstanding, and the price per share is $60. If the restructuring is expected to increasethe return on equity (ROE), what is the minimum level for EBIT that Horizon’s management must be expecting? Ignore taxes in your answer.
A firm currently carries £2m in debt and has assets in place worth £3m in state G and £1m in state B. Both states are expected to occur with the same probability. The firm has an investment opportunity which costs £1m and generates assets worth £x millions in state B and £0 in state G. Assume that managers pursue the interest of current shareholders and that, in case of bankruptcy, all assets are seized by creditors. A. The firm will undertake the project provided it has positive NPV, i.e. x/2>1 B. The firm will never undertake the project C. The firm will undertake the project provided that x>3. D. The firm will undertake the project provided that it has positive NPV in state B, i.e. x>1
Overnight Publishing Company (OPC) has $2.7 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one institution that is willing to sell it back to OPC for $2.7 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all-equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $2.7 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $1,320,000 of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 22 percent and the required rate of return on the firm's unlevered equity is 13 percent. The personal tax rate on interest income is 20 percent and there are no…
02) Overnight Publishing Company(OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retireall of its outstanding debt or to repurchase equity. The firm’s debt is held by oneinstitution that is willing to sell it back to OPC for $2.5 million. The institution will notcharge OPC any transaction costs. Once OPC becomes an all-equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $2.5 million in cash to buy back some of its stock on the open market. Repurchasing stock also hasno transaction costs. The company will generate $1,300,000 of annual earnings beforeinterest and taxes in perpetuity regardless of its capital structure. The firm immediatelypays out all earnings as dividends at the end of each year. OPC is subject to a corporatetax rate of 35 percent, and the required rate of return on the firm’s unlevered equity is20 percent. The personal tax rate on interest income is 25 percent, and there are no taxeson…
Assume that $500 million of Power’s long-term debt is due and the board of directors are meeting to discuss a proposed plan of retiring the $500 million of long-term debt and replace it with additional common stock. It is estimated that the issuance of additional stock will increase the market capitalization by $500 million. What would be the effect of these plans on Power’s Altman Z-score and its perceived risk of bankruptcy had the plan been executed just before the end of 2018? Discuss, and provide calculations to support your analysis.
Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Statement 2: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote’s value. Elona’s Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? Group of answer choices Statement 1: Pecking order theory; Statement 2: Static trade-off theory Statement 1: MM’s propositions; Statement 2: Pecking order theory Statement 1: Static trade-off theory; Statement 2: MM’s propositions Statement 1: MM’s propositions; Statement 2: Static trade-off theory PreviousNext