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 Tarun SinghWorked with Richard Gong
Ec 1745 Problem Set 71.
A) Since the total value of assets is $250 million and the market value of theexisting debt decreases by $30 million so therefore the equity increases by$30 million to $180 million.Price = Equity/# of sharesPrice = $180 million/ 15 million → Price = $12 per shareB) At a market price of $12 per share the company can buy back ($60 million/$12)= 5 million shares.C) Market Value = Equity + DebtEquity: The company bought back 5 million shares, so there are only 10million shares in the market @ $12 per share so equity is worth (10 million x$12) = $120 million.Debt: The market value of the existing debt went down to $70 million and thecompany issued $60 million more in debt so there is now ($70 million + $60million) = $130 million in debt. Thus the market value of the company is ($120 million + $130 million) =$250 million; the market value remains unchanged.D) Debt ratio = Debt/(Debt + Equity)$130 million/$250 million = .52E) Shareholders gain $30 million from the price increase in the stock whileexisting debt holders actually lose $30 million from the market value of theexisting debt falling from $100 million to $70 million.
2.
A) Equity = $80 with 50% chance and $40 with 50% chanceDebt = $0L = max (0, ((($80+$40)/2)/2)) = $30B) L = max (0, ((($80-$50)/2)/2)) + max (0, ((($40-$50)/2)/2)) = $7.50C) L = max (0, ((($100-$59)/2)/2)) + max (0, ((($60-$59)/2)/2)) = $10.50 The firm would take the project as it increases the firm’s valueD) L = max (0, ((($80-$30)/2)/2)) + max (0, ((($40-$30)/2)/2)) = $15w/ project: L = max (0, ((($100-$39)/2)/2)) + max (0, ((($60-$39)/2)/2)) =$20.50 The firm would still take the project as it increases the firm’s value
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