Chapter 18, Problem 14PS

Agency costs* Let us go back to Circular File’s market value balance sheet:

Who gains and who loses from the following maneuvers?

1. a. Circular scrapes up $5 in cash and pays a cash dividend.
2. b. Circular halts operations, sells its fixed assets, and converts net working capital into $20 cash. Unfortunately the fixed assets fetch only $6 on the secondhand market. The $26 cash is invested in Treasury bills.
3. c. Circular encounters an acceptable investment opportunity, NPV = 0, requiring an investment of $10. The firm borrows to finance the project. The new debt has the same security, seniority, etc., as the old.
4. d. Suppose that the new project has NPV = +$2 and is financed by an issue of preferred stock.
5. e. The lenders agree to extend the maturity of their loan from two years to three in order to give Circular a chance to recover.