Solution 1 Consider the firm Franklin Corporation Franklin Corporation has assets that generate cash flows in one year from now that can take three possible
Solution Consider the firm Franklin Corporation Franklin Corporation has assets that generate cash flows in one year from
Solution Consider the firm Franklin Corporation Franklin Corporation has assets that generate cash
Franklin Corporation Franklin Corporation has assets that generate cash flows in one year from now that can take three possible
Solution Consider the firm Franklin Corporation Franklin Corporation has assets that
generate cash flows in one year from now that can take three possible
Solution Consider the firm Franklin Corporation Franklin Corporation has
Solution Consider the firm
(Solution) 1 Consider the firm Franklin Corporation. Franklin Corporation has assets that generate cash-flows in one year from now that can take three possible...

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1    Consider the firm Franklin Corporation. Franklin Corporation has assets thatgenerate cash-flows in one year from now that can take three possible values: $200 million, or $100 million, or $50 million, with probabilities %, 1/4, and 1/2 respectively. There are no other cash-flows during the course of the year. The discount rate for all cash flows is 0. Franklin Corp. has 130,000 shares outstanding, and debt outstanding with face value (payable in one year) of $D million. As usual, debt is senior to equity. Franklin Corp will be closed down at the end of the year after all cash-flows have been paid out. Imagine for simplicity that all shares are currently owned by one equity holder (say, this is a family firm). Franklin Corporation has access to a new project, that costs $10 million to implement today and returns $15 million in one year for sure. Suppose the equity holder has personal funds of $10 million available which can be used to finance this project. In the questions below, you'll consider whether he will be willing to make this contribution to finance the project.a. Suppose D = 30. Show that the equity holder would be willing to contribute his own funds to undertake this project.b. Suppose D = 80. Show that the equity holder would not be willing to contribute his own funds to undertake this project. Provide intuition for why your answer is different from part (a).For the remainder of the problem, assume D = 80.c. Suppose that, in order to finance the project, the equity holder is able to issue new debt (payable in one year from now) that is senior to the existing debt. This new debt is issued to a new group of investors. If the equity holder issues such new senior debt with a face value of $10 million and uses the proceeds to invest in the project, would he and the pre-existing debtholders be better off or worse off relative to part (b)? Why is it typically not possible to issue new debt that is senior to old debt in the real world?d. Now assume instead, in contrast to part (c), that it is not possible to issue any new debt to finance the project. However, new equity financing is possible. Would the equity holder, instead of using his own personal funds, be willing to issue new equity (to a new group of investors) to finance the project? Why or why not? Be specific: compute how many new shares would have to be issued to the new shareholders in order to finance the project.e. Now suppose, in contrast to parts (c) and (d), that it is not possible to raise any form of external financing for the project. Consider instead a potential restructuring of existing debt in which existing debtholders offer today to reduce the face value of the debt due in one year from now, conditional on the equity holder contributing his personal wealth to finance the project today. Assume that the restructuring is policed by a neutral third party who can enforce the terms of the restructuring. What is the minimal amount by which existing debtholders must promise to reduce the face-value of their debt in order to pursuade the equity holder to participate in the restructuring? Discuss the potential gains, if any, to existing debtholder from agreeing to such a face-value reduction. explain carefully.

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