Consider a firm in financial distress (i.e. its assets are worth much less than the face...

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Finance

Consider a firm in financial distress (i.e. its assets are worthmuch less than the face amount of its outstanding debt, which isdue in two years).
For each scenario below, please briefly explain who stands togain and who stands to lose among the firm’s owners? Focus on theincremental gain or loss in value for each party that each scenariomay entail.
The company manages to scrape together cash and distributes itas dividends
The lenders accept to extend the maturity of their loans by oneyear
The company invests in a negative-NPV project using theremaining cash
The company raises money by issuing preferred stock and investsit in a new project with a
positive NPV
The company invests in a new project with a zero-NPV and raisesdebt to finance it; the new
debt has exactly the same level of seniority and security as theexisting debt
The company ceases operations, sells its fixed assets for anamount that is much less than the
face amount of debt and invests the proceeds in treasuries

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3.6 Ratings (331 Votes)

The company manages to scrape together cash and distributes it as dividends Stockholders or shareholders stand to gain because they got back a part of their invested capital in a situation when they would have otherwise got nothing Bondholders stand to lose as the value of the bond falls as the value of assets securing the bond has fallen The lenders accept to extend the See Answer

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Transcribed Image Text

Consider a firm in financial distress (i.e. its assets are worthmuch less than the face amount of its outstanding debt, which isdue in two years).For each scenario below, please briefly explain who stands togain and who stands to lose among the firm’s owners? Focus on theincremental gain or loss in value for each party that each scenariomay entail.The company manages to scrape together cash and distributes itas dividendsThe lenders accept to extend the maturity of their loans by oneyearThe company invests in a negative-NPV project using theremaining cashThe company raises money by issuing preferred stock and investsit in a new project with apositive NPVThe company invests in a new project with a zero-NPV and raisesdebt to finance it; the newdebt has exactly the same level of seniority and security as theexisting debtThe company ceases operations, sells its fixed assets for anamount that is much less than theface amount of debt and invests the proceeds in treasuries