Project NPV and gaining shareholder votes
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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?
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The solution discusses the project NPV and gaining shareholder votes.
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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 ...
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