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# Project NPV and gaining shareholder votes

1. A firm has debt with a face value of \$100. Its projects will pay a safe \$80 tomorrow. Managers care only about shareholders. A new quickie project comes along that costs \$20, earns either \$10 or \$40 with equal probabilities, and does so by tomorrow.
A. Is this a positive NPV project?
B. If the new project can only be financed with a new equity issue, would the shareholders vote for this? Would the creditors?
C. Assume the existing bond contract was written in a way that allows the new projects to be financed with first collateral (superseniority with respect to the existing creditors). New creditors can collect \$20 from what the existing projects will surely pay. Would the existing creditors be better off?
D. What is the better arrangement from a firm-value perspective?

#### Solution Preview

Face value of Debt = \$100
Current risk free value of firm's projects=\$80
Cost of the new project =\$20
Payoff from new project = \$10 with 50% probability & \$40 with 50% probability

A. Is this a positive NPV project?
Expected payoff = \$10*0.5+\$40*0.5=\$25
NPV = -\$20+\$25=\$5.00
Hence, it is a positive NPV project

B. If the new project can only be financed with a new equity issue, would the shareholders vote for this? Would the ...

#### Solution Summary

The solution discusses the project NPV and gaining shareholder votes.

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