solution

  1. Firm B Corp has debt with a face (book) value of $150 million and 10 million shares outstanding. The debt is due tomorrow, but we don’t yet know what the value of the assets will be. The distribution of possible asset values tomorrow is shown in the table below.

Prob.

0.1

0.2

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0.4

0.2

0.1

Asset Value

50

100

200

300

350

  1. What is the market value of B Corp’s assets? Debt? Equity? What is B Corp’s stock price?
  1. Suppose B Corp wanted to sure up its balance sheet by issuing $100 million in new equity and holding the proceeds as cash, and imagine that it could do that by selling shares at the market price from part a. How would this equity issuance affect the market value balance sheet? (That is, re-calculate all of the values you calculated in part a.)
  1. Would shareholders want to do this equity issuance?
  1. Suppose the firm has access to a very attractive project and that it could use the proceeds of the equity issuance from part b to fund this project (rather than holding them as cash). The project costs $100 million and pays off $100 million + X tomorrow in each possible outcome (X is the same for each outcome and represents the NPV of the project). How large would the NPV have to be for shareholders to want this equity issuance and investment to happen?
 
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