Case Study: Capital Structure Part 1: Case Background MarCher Industries is considering undertaking

Case Study: Capital Structure

Part 1: Case Background

MarCher Industries is considering undertaking a new project with a one-year life with the following expected return scenarios

Scenario 1 HIGH-RISK PROJECT Scenario 2 LOW-RISK PROJECT
Cash flow (boom)
Cash flow (bust)

The company currently has no debt, but is considering borrowing

Part 2: Case Analysis

1) Calculate the expected value of the high- and low-risk projects to MarCher Industry’s stockholders if the company remains unlevered Which project would the stockholders prefer?

2) Calculate the expected value of the high- and low-risk projects to MarCher’s stockholders and bondholders, assuming the company does borrow money to partially finance the purchase of the project Which project would the bondholders prefer? Which project would the stockholders prefer?

3) Explain why a conflict exists between the bondholders and the stockholders

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