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Value of the company with or without expansion

From Corporate Finance 9/e (Ross, Westerfield, Jaffe) pg 552

Company plans to expand in one year.

Has outstanding bond with face value of $34 million due in one year.
Bond covenants prohibit issuance of additional debt.
Expansion will be equity financed at cost of $8.4 million.

State of comapny in three states if economy with or without expansion:

Economic growth probability with expansion without expansion

low .30 $30,000,000 $33,000,000

normal .50 35,000,000 46,000,000

high .20 51,000,000 64,000,000

Calculate:

1. Expected value of company in one year, with and without expansion

2. expected value of debt in one year, with and without expansion

3. in one year how much value creation from expansion?
how much for stockholder? Bondholder?

4. if company does not expand, what happens to price of bonds?
what happens to price if they do expand?

5. if no expansion, what are implications for future borrowing needs?
what are implications if it does expand?

6. How would answer be affected if expansion were financed with cash
on hand instead of new equity?

Solution Preview

See the attached file. Thanks

mckenzie corporation's corporate structuring

Company plans to expand in one year. 

Has outstanding bond with face value of $34 million due in one year. 
Bond covenants prohibit issuance of additional debt. 
Expansion will be equity financed at cost of $8.4 million. 

State of company in three states if economy with or without expansion: 

Economic Growth Probability With Expansion Without Expansion

Low 0.3 $30,000,000 $33,000,000
Normal 0.5 $35,000,000 $46,000,000
High 0.2 $51,000,000 $64,000,000

Calculate: 

1. Expected value of company in one year, with and without expansion 
With Expansion Without Expansion
Expected value $36,700,000 $45,700,000 ...

Solution Summary

This post has multiple problems. It shows how to calculate expected value of company and debt , with and without expansion and how much value creation from expansion, for stockholder and Bondholder. It discusses about price of bonds etc.

$2.19