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 Industryâ€™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 MarCherâ€™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