PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 24, Problem 27PS
Convertible bonds This question illustrates that when there is scope for the firm to vary its risk, lenders may be more prepared to lend if they are offered a piece of the action through the issue of a convertible bond. Ms. Blavatsky is proposing to form a new start-up firm with initial assets of $10 million. She can invest this money in one of two projects. Each has the same expected payoff, but one has more risk than the other. The relatively safe project offers a 40% chance of a $12.5 million payoff and a 60% chance of an $8 million payoff. The risky project offers a 40% chance of a $20 million payoff and a 60% chance of a $5 million payoff.
Ms. Blavatsky initially proposes to finance the firm by an issue of straight debt with a promised payoff of $7 million. Ms. Blavatsky will receive any remaining payoff. Show the possible payoffs to the lender and to Ms. Blavatsky if (a) she chooses the safe project and (b) she chooses the risky project. Which project is Ms. Blavatsky likely to choose? Which will the lender want her to choose?
Suppose now that Ms. Blavatsky offers to make the debt convertible into 50% of the value of the firm. Show that in this case the lender receives the same expected payoff from the two projects.
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Scenario one: Under what circumstances would it be appropriate for a firm to use different cost of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier division or the more conservative divisions tend to get most of the investment projects? Why? If you were to try to estimate the appropriate cost of capital for different divisions, what problems might you encounter? What are two techniques you could use to develop a rough estimate for each division’s cost of capital?
Scenario three: If a portfolio has a positive investment in every asset, can the expected return on a portfolio be greater than that of every asset in the portfolio? Can it be less than that of every asset in the portfolio? If you answer yes to one of both of these questions, explain and give an example for your answer(s).
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Chapter 24 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 24 - Bond terms Use Table 24.1 (but not the text) to...Ch. 24 - Bond terms Look at Table 24.1: a. The AMAT bond...Ch. 24 - Bond terms Select the most appropriate term from...Ch. 24 - Prob. 5PSCh. 24 - Bond terms Bond prices can fall either because of...Ch. 24 - Security and seniority a. As a senior bondholder,...Ch. 24 - Prob. 8PSCh. 24 - Prob. 9PSCh. 24 - Security and seniority a. Residential mortgages...Ch. 24 - Sinking funds For each of the following sinking...
Ch. 24 - Call provisions a. Look at Table 24.1. Suppose...Ch. 24 - Covenants Alpha Corp. is prohibited from issuing...Ch. 24 - Prob. 14PSCh. 24 - Private placements Explain the three principal...Ch. 24 - Convertible bonds True or false? a. Convertible...Ch. 24 - Convertible bonds Maple Aircraft has issued a 4%...Ch. 24 - Convertible bonds The Surplus Value Company had 10...Ch. 24 - Prob. 19PSCh. 24 - Convertible bonds Iota Microsystems 10%...Ch. 24 - Convertible bonds Zenco Inc. is financed by 3...Ch. 24 - Prob. 22PSCh. 24 - Prob. 23PSCh. 24 - Bank loans, commercial paper, and medium-term...Ch. 24 - Prob. 25PSCh. 24 - Tax benefits Dorlcote Milling has outstanding a 1...Ch. 24 - Convertible bonds This question illustrates that...Ch. 24 - Prob. 28PS
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