The TBY Corporation has fallen on hard times. It has debt with face value of $5...

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The TBY Corporation has fallen on hard times. It has debt with face value of $5 million that will come due at the end of the year. It has $1 million in cash. It has two projects it can invest this $1 million in. These projects generate the following payoffs just before the end of the year. Project A $10 million with probability 0.05 $0.5 million with probability 0.95 Project B $5.5 million with probability 1 Both bond holders and stock holders are risk neutral and so are only interested in the expected payoffs on their securities. They discount payoffs at the end of the year by 10 percent. (a) (b) Suppose the TBY Corporation's covenants on its debt prevent it from paying any dividends while the firm's debt is outstanding. What would the equity holders prefer the firm to do? What would the bond holders prefer the firm to do? Explain why in both cases. How would your answer to (a) be changed if the covenants on the firms' debt were such that it was prevented from paying dividends while the firm's debt was outstanding except that it could pay out the $1 million in cash as dividends? The TBY Corporation has fallen on hard times. It has debt with face value of $5 million that will come due at the end of the year. It has $1 million in cash. It has two projects it can invest this $1 million in. These projects generate the following payoffs just before the end of the year. Project A $10 million with probability 0.05 $0.5 million with probability 0.95 Project B $5.5 million with probability 1 Both bond holders and stock holders are risk neutral and so are only interested in the expected payoffs on their securities. They discount payoffs at the end of the year by 10 percent. (a) (b) Suppose the TBY Corporation's covenants on its debt prevent it from paying any dividends while the firm's debt is outstanding. What would the equity holders prefer the firm to do? What would the bond holders prefer the firm to do? Explain why in both cases. How would your answer to (a) be changed if the covenants on the firms' debt were such that it was prevented from paying dividends while the firm's debt was outstanding except that it could pay out the $1 million in cash as dividends?

Answer rating: 100% (QA)

a If the TBY Corporations covenants on its debt prevent it from paying any dividends while the firms ... View the full answer