4. Company X has the following market value balance sheet: Cash $5 $25 Bonds out
ID: 2794089 • Letter: 4
Question
4. Company X has the following market value balance sheet:
Cash $5 $25 Bonds outstanding
Net Working Capital $15 $5 Common stock
PV of future CFs $10
Who is likely to gain and who is likely to lose from the following maneuvers? (Assume that the
risk-free rate is zero. Also, suppose that the debt is risky). You may want to (but are not required
to) use numerical examples to support your conclusions.
a. Company X pays a cash dividend of $5 to its shareholders.
b. Company X halts operations, sells its fixed assets, and converts net working capital into $15
cash. Unfortunately the fixed assets fetch only $6 on the second-hand capital goods market.
The $26 cash is invested in Treasury Bills. (Here you can think of fixed assets as machinery
that would produce future cash flows with PV=$10 if the firm kept operating. Since the fixed
assets are sold, these future cash flows will not be realized now).
Explanation / Answer
Computation of Fixed Assets
a. The investor are likely to gain i first part of question due to cash inflows of $5
b. Loss to company on account of sale of fixed assets = $ 4
The moment sale of fixed asset take place cash inflow recevaibles is Nil
There is no relevance of investing $ 26 in Treasury Bills on basis of assumption given in question of Risk Free Rate is zero.
On the contrary the amount realised from sale of fixed assets should have been invested in return genrating assets so that future cash flow could have been generated and present value of same could be computed .
Also, there is no relevance of converting the working capital into cash ,as cash in hand is nothing but non interest bearing amount.
Particulars Assets Particulars Liabilities Cash 5 Bonds 25 Net Working Capital 15 Stock 5 Fixed Assets 10 ( B/F)Related Questions
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