Corporate Finance Plus MyLab Finance with Pearson eText -- Access Card Package (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series)
4th Edition
ISBN: 9780134408897
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 16, Problem 6P
Suppose Tefco Corp. has a value of $100 million if it continues to operate, but has outstanding debt of $120 million that is now due. If the firm declares bankruptcy, bankruptcy costs will equal $20 million, and the remaining $80 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?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
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?
Tefco could offer its creditors% of the firm in a workout. (Round to one decimal place.)
C
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
Fountain Corporation’s economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of the company must choose between two mutually exclusive projects. Assume that the project the company chooses will be the firm’s only activity and that the firm will close one year from today. The company is obligated to make a $4,200 payment to bondholders at the end of the year. The projects have the same systematic risk but different volatilities. Consider the following information pertaining to the two projects:
Economy
Probability
Low-Volatility Project Payoff
High-Volatility Project Payoff
Bad
.50
$ 4,200
$ 3,400
Good
.50
4,600
4,900
a.
What is the expected value of the company if the low-volatility project is undertaken? What if the high-volatility project is undertaken? (Do not round intermediate calculations.)
b.
What is the expected value of the company’s equity if the low-volatility…
Chapter 16 Solutions
Corporate Finance Plus MyLab Finance with Pearson eText -- Access Card Package (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series)
Ch. 16.1 - Prob. 1CCCh. 16.1 - Does the risk of default reduce the value of the...Ch. 16.2 - If a firm files for bankruptcy under Chapter 11 of...Ch. 16.2 - Why are the losses of debt holders whose claims...Ch. 16.3 - Prob. 1CCCh. 16.3 - True or False: If bankruptcy costs are only...Ch. 16.4 - Prob. 1CCCh. 16.4 - According to the trade-off theory, all else being...Ch. 16.5 - Prob. 1CCCh. 16.5 - Why would debt holders desire covenants that...
Ch. 16.6 - Prob. 1CCCh. 16.6 - Prob. 2CCCh. 16.7 - Coca-Cola Enterprises is almost 50% debt financed...Ch. 16.7 - Why would a firm with excessive leverage not...Ch. 16.7 - Describe how management entrenchment can affect...Ch. 16.8 - How does asymmetric information explain the...Ch. 16.8 - Prob. 2CCCh. 16.9 - Prob. 1CCCh. 16.9 - Prob. 2CCCh. 16 - Gladstone Corporation is about to launch a new...Ch. 16 - Baruk Industries has no cash and a debt obligation...Ch. 16 - When a firm defaults on its debt, debt holders...Ch. 16 - Prob. 4PCh. 16 - Prob. 5PCh. 16 - Suppose Tefco Corp. has a value of 100 million if...Ch. 16 - You have received two job offers. Firm A offers to...Ch. 16 - As in Problem 1, Gladstone Corporation is about to...Ch. 16 - Kohwe Corporation plans to issue equity to raise...Ch. 16 - Prob. 10PCh. 16 - Prob. 11PCh. 16 - Hawar International is a shipping firm with a...Ch. 16 - Your firm is considering issuing one-year debt,...Ch. 16 - Marpor Industries has no debt and expects to...Ch. 16 - Real estate purchases are often financed with at...Ch. 16 - On May 14, 2008, General Motors paid a dividend of...Ch. 16 - Prob. 17PCh. 16 - Consider a firm whose only asset is a plot of...Ch. 16 - Prob. 19PCh. 16 - Prob. 20PCh. 16 - Prob. 21PCh. 16 - Consider the setting of Problem 21 , and suppose...Ch. 16 - Consider the setting of Problems 21 and 22, and...Ch. 16 - You own your own firm, and you want to raise 30...Ch. 16 - Empire Industries forecasts net income this coming...Ch. 16 - Ralston Enterprises has assets that will have a...Ch. 16 - Prob. 27PCh. 16 - If it is managed efficiently, Remel Inc. will have...Ch. 16 - Which of the following industries have low optimal...Ch. 16 - According to the managerial entrenchment theory,...Ch. 16 - Info Systems Technology (IST) manufactures...Ch. 16 - Prob. 32PCh. 16 - Prob. 33P
Additional Business Textbook Solutions
Find more solutions based on key concepts
Financial statement analysis. Introduction: Financial ratio analysis: Financial ratio analysis is a tool of fin...
Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
(Future and present value using a calculator) In 2016 Bill Gates was worth about $82 billion. Let’s see what Bi...
Foundations Of Finance
The cost of debt, equity and the weighted average capital cost are the financial leverages of the firm. The opt...
Principles of Managerial Finance (14th Edition) (Pearson Series in Finance)
(PI calculation) Calculate the PI given the following free cash flows if the appropriate required rate of retur...
Foundations of Finance (9th Edition) (Pearson Series in Finance)
Calculate retained earnings balance. (LO 5). Suppose Hillard Company started the year with a balance of $450,00...
Financial Accounting
1-1. Define marketing and outline the steps in the marketing process. (AASCB: Communication)
Marketing: An Introduction (13th Edition)
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Fountain Corporation’s economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of the company must choose between two mutually exclusive projects. Assume that the project the company chooses will be the firm’s only activity and that the firm will close one year from today. The company is obligated to make a $4,100 payment to bondholders at the end of the year. The projects have the same systematic risk but different volatilities. Consider the following information pertaining to the two projects: Economy Probability Low-Volatility Project Payoff High-Volatility Project Payoff Bad .50 $ 4,100 $ 3,500 Good .50 4,600 5,200 a. What is the expected value of the company if the low-volatility project is undertaken? The high-volatility project? (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) b. What is the expected value of the…arrow_forwardSheaves Corporation economists estimate that a good business environment and a bad business environment are equally likely for the coming year. Management must choose between two mutually exclusive projects. Assume that the project chosen will be the firm’s only activity and that the firm will close one year from today. The firm is obligated to make a $5,400 payment to bondholders at the end of the year. The projects have the same systematic risk, but different volatilities. Consider the following information pertaining to the two projects: Economy Probability Low-VolatilityProject Payoff High-VolatilityProject Payoff Bad .50 $5,400 $4,800 Good .50 6,550 7,150 a. What is the expected value of the firm if the low-volatility project is undertaken? What if the high-volatility project is undertaken? (Do not round intermediate calculations and round your answers to the nearest whole dollar, e.g., 32.) b. What is the…arrow_forwardA 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>1arrow_forward
- Axon Industries needs to raise $22.41M for a new investment project. If the firm issues one-year debt, it may haveto pay an interest rate of 9.44 %, although Axon's managers believe that 5.51 % would be a fair rate given the level of risk. If the firm issues equity, they believe the equity may be underpriced by 11.26 %. What is the cost to current shareholders of financing the project out of Equity? NOTE: Provide your answers in Millions. E.G. for 100M you must enter 100.0000, for 20M you must enter 20.0000, etc.arrow_forwardOvernight 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…arrow_forward02) 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…arrow_forward
- Gladstone Corporation is about to launch a new product. Depending on the success of the new product, Gladstone may have one of four values next year: $151 million, $134 million, $91 million, and $84 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 20% of the value of Gladstone's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.) a. What is the initial value of Gladstone's equity without leverage? Now suppose Gladstone has zero-coupon debt with a $100 million face value due next year. b. What is the initial value of Gladstone's debt? c. What is the yield-to-maturity of the debt? What is its expected return? d. What is the initial value of Gladstone's equity? What is Gladstone's total value with leverage? Suppose Gladstone has 10 million shares outstanding and no debt at the start of the year. e. If Gladstone does not issue debt, what…arrow_forwardGreen Mfg is about to launch a new product. Depending on the success of the new product, they will have one of four values next year: $150 million, $140 million, $95 million, and $82 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 30% of the value of their assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.) a. What is the initial value of Green's equity without leverage? Now suppose Green has zero-coupon debt with a $100 million face value due next year. b. What is the initial value of Green's equity? What is Green's total value with leverage?arrow_forward7. You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass erystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is S540,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be ifit uses some debt rather than all equity, i.e., what is ROEL. - ROEU? Do not round your intermediate calculations. 0% Deht, U Oper. income (EBIT) Required investment S540,000 $2,500,000 0.0% 60% Debt, L S540,000 $2,500,000 % Debt S of Debt S of Common equity 60.0% S0.00 $1,500,000 S1,000,000 $2,500,000 NA 35% Interest rate 10.00% Tax rate 35% a. 10.74% b. 13.57% c. 14.14% d. 11.88% e. 11.31%arrow_forward
- Please answerarrow_forwardPlease help solve and show work. As a firm takes on more debt, its probability of bankruptcy ___ . Other factors held constant, a firm whose earnings are relatively volatile faces a ____ chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use ____ debt than a more stable firm. When bankruptcy costs become more important, they ____ the tax benefits of debt. Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm’s unlevered beta is 1.05, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (rRFrRF) is 4%, and the market risk premium (RPMRPM) is 8%. Blue Ram’s marginal tax rate is 25%. Blue Ram is examining how different levels of debt will affect its costs of debt and…arrow_forwardDavid Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during the next 3 years: FCF2 = 290,000 and FCF3 = 320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is 128,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY