Financial Distress Assignment | Homework For You

Problem 5 (10%) Your firm currently faces financial distress with $1 million in debt. Your firm has an investment opportunity that requires equity holders to contribute an initial investment of $100,000 and will generate a risk-free return of 50%. Assume that the current risk-free rate is 5%. Their payoff at the end of the year is shown in the table below:

 Existing New project Total female Debe Equity Without New Project 900 With New Project fie., issuing equity). 900 900

Now your firm is considering in reducing leverage from $1 million to $400,000 by buying back debt 900 150 TOSO 1000

11) Show that the shareholders would not gain by reducing leverage, even though firm value would increase by eliminating the cost of underinvestment? (5%) olders do not have an incentive to decrease leverage when they are in

(2) Explain why the shareholders do not have an incentive to decrease leverage financial distress, even if it will increase the value of the firm? (5%). Get Finance homework help today