You own debt with face amount of $150 Million that you lent to a firm managed by its sole shareholder, whose firm is expected to generate next year either a cash flow of $200 Million with probability .6, or $100 Million with probability .4. This is a one-time, one year project and then the firm will be shut down. In addition there is a project P that will generate $40 Million in either state next year. This new project requires funding of $30 million which the firm does not have, and so say he would have to issue junior debt to obtain the capital to undertake the project. Assume that all cash flows are discounted at 0%. a. Do you expect the manager to undertake the new project P? Explain how he would acquire the capital – in other words, what is the face value for the new junior debt. (The existing debt has a pari passu covenant it turns out that disallows senior debt)? b. The manager asks you to forgive $40 million in debt down to a new face value of $110 million. Again calculate what the face value would need to be for the junior debt and determine if the manager will now undertake the project with this restructuring plan. c. Will you accept the manager’s request for the debt forgiveness of $40 million as is? If you reject the plan as is, determine if there is an equity stake that you could demand that would get everyone on board and split the surplus created by the project evenly. That is, what share of the equity would be needed in compensation for the best outcome with an equal split of the surplus created. Specifically, if the owner currently held 7 shares, how many shares of equity would you demand for an even split? d. You decide that you do not want equity due to institutional reasons, so you could offer, instead, to invest the $30 million in the firm in return for Junior debt. This is therefore much like part (a) except that you, rather than an outside investor, will be the Junior debt holder. What face value for the Junior debt would lead to an optimal outcome with an even split of the surplus?
You own debt with face amount of $150 Million that you lent to a firm managed by its sole shareholder, whose firm is expected to generate next year either a cash flow of $200 Million with probability .6, or $100 Million with probability .4. This is a one-time, one year project and then the firm will be shut down. In addition there is a project P that will generate $40 Million in either state next year. This new project requires funding of $30 million which the firm does not have, and so say he would have to issue junior debt to obtain the capital to undertake the project. Assume that all cash flows are discounted at 0%.
a. Do you expect the manager to undertake the new project P? Explain how he would acquire the capital – in other words, what is the face value for the new junior debt. (The existing debt has a pari passu covenant it turns out that disallows senior debt)?
b. The manager asks you to forgive $40 million in debt down to a new face value of $110 million. Again calculate what the face value would need to be for the junior debt and determine if the manager will now undertake the project with this restructuring plan.
c. Will you accept the manager’s request for the debt forgiveness of $40 million as is? If you reject the plan as is, determine if there is an equity stake that you could demand that would get everyone on board and split the surplus created by the project evenly. That is, what share of the equity would be needed in compensation for the best outcome with an equal split of the surplus created. Specifically, if the owner currently held 7 shares, how many shares of equity would you demand for an even split?
d. You decide that you do not want equity due to institutional reasons, so you could offer, instead, to invest the $30 million in the firm in return for Junior debt. This is therefore much like part (a) except that you, rather than an outside investor, will be the Junior debt holder. What face value for the Junior debt would lead to an optimal outcome with an even split of the surplus?
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