Question

Consider a firm in Chapter 11. The firm has $5.5m senior debt and $7.5m junior debt. The junior & senior claim- holders debate the firm value in reorganization. One group argues that the value of the firm in reorganization is $6m, the other argues the value is $14m. (Assume the true value of the company is $8m.)

1.) Which party would benefit from a valuation of $6m in a debt for equity exchange?

2.) Which party would benefit from a valuation of $14m in a debt for equity exchange?

3.) How much equity would junior and senior claim holders would get if the valuation of $6m or $14m is accepted?

4.) Which party would be shortchanged if the $6m valuation is accepted instead of $8m?

5.) Which party would be shortchanged if the $14m valuation is accepted instead of $8m?

Answer 1

1. none of the parties would be benefited since total debt is 7.5+5.5 = 13 and firm value is 6

2. both the parties would be benefitted since total debt is 13 and firm value is 14 and therefore in equity exchange both will get more proportion

3. if value = 6, then junior will get = 6 * 5.5/13 = 2.53846 and senior will get = 6 * 7.5/13 = 3.461538

if value = 14 then junior will get = 14*5.5/13 = 5.9230 and senior will get = 14*7.5/13 = 8.076923

4. if value= 6 then as we can see in answer part3 both vl be shortchanged

5. if value= 14 then as we can see in part3 answer, none will be short changed