Assume that value of Sam's assets was $1.7B before the investment and that the risk free rate is 10% P/A [annual compounding].
The value of assets of Sam corp. will be either $2.2 B or $1.6 B in a year from now. Sam issued some time ago a zero-coupon with face value of $2B;
the bond will mature a year from now.
Sam Corp. has now an opportunity to invest $100MM into a project with a certain [i.e., risk-free] PV=$200 MM and NPV=$100MM. If investment is made, the value of Sam assets next year will be either $2.42 B or $1.82 B ;
1. Calculate the value of Sam equity before and after the additional investment of $100MM.
2. How will the $100MM NPV gain be divided between bondholders and stockholders
3. Will stockholders provide the $100 MM needed for this very profitable project?
4. Bondholders refuse to provide the $100MM financing and ask stockholders to contribute.? But Sam Corp threatens the bondholders that if they don't provide the financing they will change the business activity of the company so that the value of assets next year is either $3B or $1B and value of assets today is $1.2B.? Would shareholders benefit from this change?? Assuming that stock holders refuse to add any new funds, should the existing bondholders provide additional $100MM financing? Explain.
This question was answered on: Sep 18, 2020
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