The Schuhmacher corporation has debt outstanding. The total amount that it will

Question

The Schuhmacher corporation has debt outstanding. The total amount that it will have to pay to bondholders in one year's time at date 1 is $100 million. The firm's position since it has issued the debt five years about has steadily deteriorated. It only remaining asses its $25 million in cash. If it does nothing the bondholders will receive all the cat and any interest the cash might earn. The firm has the option to undertake a project that cost $25 million today and at date 1 there is a 5% chance of success, which yields 200 million payoff. However, with 95% probability, the project will pay nothing. Thats the elected payoff to debt holders in date 17? A) 5 Million B) 10 Million C) 25 Million D) 15 million

Explanation / Answer

NPV of the project = PV of cash inflow – cash outflow

                                     = (0.05 x 200 million + 0.95 x0) – 25 million

                                    = -15 million

So this project will not be undertaken as NPV of this project is negative.

Payoff for debtholders = cash flows available with the firm

                                                = 25 million

So 25 million will be paid to the bondholders.

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