In the Miller-Modigliani world of no taxes, the Grainville Corporation (GC) has a zero-coupon bond issue with a face value of $2,000 that is coming due in one year. The value of GC’s assets is currently $2,400. Chris Denison, the omnipotent CEO, believes that the assets in the firm will be worth $1,400 or $3,400 in a year. The risk-free rate is 2 percent per annum. What is the current value of the firm’s equity? The current value of the debt? Brad Batman, the CFO, argues that GC can reconfigure its existing assets such that the value in a year will be $400 or $4,000. If the current value of the assets remains unchanged, would the stockholders favor such a move? Explain why or why not?
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