Suppose that managers have more information than outside investors about the company's projects and expected cash...
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Suppose that managers have more information than outside investors about the company's projects and expected cash flows. Outside investors cannot tell apart whether the company has in place good quality assets (that produce cash flows of £100) or bad quality assets (that produce cash flows of £50). Managers know that the company has in place good quality assets. The discount rate is zero. Assume that the managers act in the interest of the existing equityholders of the company. a) The company has access to a safe project that costs £10 to finance and produces cash flows of £20 tomorrow. Assume that the only way to finance the project is by issuing equity. If outside investors attribute a probability 50% that the company has good assets and 50% that the company has bad assets, what is the minimum value of the shares of the company that has to be sold to the outside equityholders so that this project can be financed with outside equity. Is the project going to be executed? Explain your answer. [6 marks] b) The company has access to a safe project that costs £X to finance and produces cash flows of £20 tomorrow. Assume that the only way to finance the project is by issuing equity. If outside investors attribute a probability 50% that the company has good assets and 50% that the company has bad assets, what is the maximum value of X so that this project can be financed with outside equity? [6 marks] c) The company has access to a safe project that costs £10 to finance and produces cash flows of £20 tomorrow. Assume that the only way to finance the project is by issuing debt. If outside investors attribute a probability p that the company has good assets and 1-p that the company has bad assets, what is the minimum value of p so that this project can be financed with debt? Suppose that managers have more information than outside investors about the company's projects and expected cash flows. Outside investors cannot tell apart whether the company has in place good quality assets (that produce cash flows of £100) or bad quality assets (that produce cash flows of £50). Managers know that the company has in place good quality assets. The discount rate is zero. Assume that the managers act in the interest of the existing equityholders of the company. a) The company has access to a safe project that costs £10 to finance and produces cash flows of £20 tomorrow. Assume that the only way to finance the project is by issuing equity. If outside investors attribute a probability 50% that the company has good assets and 50% that the company has bad assets, what is the minimum value of the shares of the company that has to be sold to the outside equityholders so that this project can be financed with outside equity. Is the project going to be executed? Explain your answer. [6 marks] b) The company has access to a safe project that costs £X to finance and produces cash flows of £20 tomorrow. Assume that the only way to finance the project is by issuing equity. If outside investors attribute a probability 50% that the company has good assets and 50% that the company has bad assets, what is the maximum value of X so that this project can be financed with outside equity? [6 marks] c) The company has access to a safe project that costs £10 to finance and produces cash flows of £20 tomorrow. Assume that the only way to finance the project is by issuing debt. If outside investors attribute a probability p that the company has good assets and 1-p that the company has bad assets, what is the minimum value of p so that this project can be financed with debt?
Expert Answer:
Answer rating: 100% (QA)
To determine the minimum value of shares that need to be sold to outside equityholders to finance the project we need to consider the expected cash flows from the project and the probabilities assigne... View the full answer
Related Book For
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta
Posted Date:
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