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Debt-Holder's Contingent Claim

7. The Splitz Corporation borrowed $5 million with a promise to repay $5.5 million in one year. The corporation had 10 million shares outstanding worth $2 each at the time of the borrowing. Splitz earned $5 million during the year. What is the debt-holder's contingent claim; how much does the debt-holder receive; and how much do the equity holders receive?
Debt-holder's contingent claim Debt-holder receives Equity holders receive
(A) 5 5.5 20
Debt-holder's contingent claim Debt-holder receives Equity holders receive
(B) 5.5 5 0
Debt-holder's contingent claim Debt-holder receives Equity holders receive
(C) 5 -.5 20
Debt-holder's contingent claim Debt-holder receives Equity holders receive
(D) -.5 5 0

Solution Preview

Let the value of the firm is $X and debt holders are promised $F. Algebraically, the bondholder's claim is: Min[$F,$X]
Algebraically, the shareholder's ...

Solution Summary

This solution identifies how much the equity holders receive by selecting and showing step-by-step calculations for the correct answer.

$2.19