CapStr Notes 20185 - OneNote File Home Insert Draw History Review View Qingzhong Ma LL Qingzhong @ California Stat.. . BinZero FINA351 FINA480 FINA101 + Search (Ctrl+ E) inefficiency. That is, in the presence of maturing debt managers prefer lower NP V projects + Add Page that pay off more quickly over higher NPV ones that pay later. CapStr N CapStr N Example Company ABAC's existing assets will generate cash flow of $100m in year 1 and either $120m or $20m in year 2, depending on the state of the economy. The two states are equally likely. The firm has debt of $200m due in year 1 and $80m in year 2. In order to make the ends meet, the firm is considering taking one of the two projects. The two projects are equally costly and mutually exclusive. Project A makes cash flow of $100m in year 1 and zero in year 2, while project B generates $40m and $80m in year 1 and year 2, respectively. Assume zero interest rate, risk neutrality and no direct bankruptcy costs. Analysis Which project is better for the firm? Tuesdays are O Type here to search 9 equally likely. 10:31 AM 3/4/2018 11 ) 1:14 / 4:56 cc 1xCapStr Notes 20185 - OneNote File Home Insert Draw History Review View Qingzhong Ma LL Qingzhong @ California Stat.. . BinZero FINA351 FINA480 FINA101 Search (Ctrl+ E) The firm has debt Of $20om due in year I and boom in year 2. + Add Page In order to make the ends meet, the firm is considering taking one of the two projects. The CapStr N two projects are equally costly and mutually exclusive. CapStr N Project A makes cash flow of $100m in year 1 and zero in year 2, while project B generates $40m and $80m in year 1 and year 2, respectively. Assume zero interest rate, risk neutrality and no direct bankruptcy costs. Analysis Which project is better for the firm? 2 A : PV = 100 / ( H. D ) 100 O 2 B PUR= + 4 0 =120 40 80 ( It.0 ) ( It. 0 ) when we look at the O Type here to search M 9 value of the projects, 10:34 AM 3/4/2018 II () 4:23 / 4:56 cc 1x XCapStr Notes 20185 - OneNote Qingzhong Ma File Home Insert Draw History Review View Search (Ctrl+ E) O . Qingzhong @ California Stat.. BinZero FINA351 FINA480 FINA101 + + Add Page CapStr N Shortsightedness (continued) CapStr N Which project will the managers choose? Take B year ! year 2 Debt due 200 80 for Ji.D CF in 100 -+ 40 120 + 80= 200 IXP+ : 120 = 60 + 80 = 100 Need fin ? yes. ($ 60 P = 100 E for Pr Sr. DI Jr.D E = 10 P 120- P 20 0 Take A year 1 year 2 Debt due CF in 100+ 100 120+0 D= 50 Need fin 20 + 0 No D 80 E = = 20 which is the total amount 10:51 AM 3/4/2018 Play clip O Type here to search cc 1x 12:03 / 14:50CapStr Notes 20185 - OneNote File Home Insert Draw History Review View Qingzhong Ma LL Qingzhong @ California Stat.. . BinZero FINA351 FINA480 FINA101 + Search (Ctri+E) + Add Page he of gains ( A s. S. B ) CapStr N B A A - B CapStr N E 10 20 + 10 year z D 80 50 - 30 Jr. D in year 2 60 - 60 = 0 ( fair Deal ) Png PV 120 100 20 4PV A E + J D = 4 PV 80 Financial Management Applications 53 O Type here to search 0 9 Noas the cashflows to 10:53 AM 3/4/2018 () 14:41 / 14:50 CC 1x X