Question

The ABC company is in financial distress, has USD 10,000 in cash, and debt with face value USD 50,000 due next year. The ABC company has the possibility to invest in a project which requires an investment of all its USD 10,000 cash and is expected to produce a cash flow next year of USD 100,000 with probability 5 percent, and USD 100,000 otherwise. Assume a discount rate of 20 percent throughout. By implementing the project vs doing nothing, by how much does shareholder value increase? (answer is roughly 2083).

Answer 1

Solution :-

If company invest in A Project , the Share Holder Value increase =

Expected Cash flow next year = ( 0.05 * $100,000 ) + ( 0.95 * $100,000 ) = $100,000

Now Amount after Paying Debt Left = $100,000 - $50,000 = $50,000

Now the Present Value of Amount = $50,000 / ( 1 + 0.20 ) = $41,666.67

Now Net Value increase = $41,666.67 - $10,000 = $31,666.67

Shareholder value increase by $31,666.67

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