1. RRR Ltd. is a levered firm. It has taken debt from two banks. It has a...
Question:
1. RRR Ltd. is a levered firm. It has taken debt from two banks. It has a senior debt obligation of 40 million due this period and 200 next period. It also has a subordinated debt from NBFC of 40 and due next period. It has no projects to provide cash flows this period. Therefore, if the RRR Ltd. cannot get a loan of 40, it must liquidate. The firm has a current liquidation value of 240. If the firm does not liquidate, it can take one of the two projects from two state governments with no additional investment. If it takes Telangana project, it will be received cash flows of 270 next period certainly. If the firm takes Andhra project, it will receive either cash flows of 322 or 138 with 60:40 probability. Assume risk neutrality, a zero interest rate, no direct bankruptcy costs, and no taxes.
a. Which one has higher present value: liquidating, Telangana project; Andhra project?
b. Do you think that NBFC agree to loan the firm the 40 it needs to stay operating if they receive a (subordinated) bond with a face value of 41?
c. If the firm does receive the loan from NBFC, which project will the managers choose if they act in the interest of the equity holders?
Financial Reporting and Analysis
ISBN: 978-0078025679
6th edition
Authors: Flawrence Revsine, Daniel Collins, Bruce, Mittelstaedt, Leon