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) $1,500,000 $1,000,000
Cash flow (bust) $400,000 $500,000
The company currently has no debt, but is considering borrowing $870,000 on a short-term basis to help finance its purchase of the project. The company will owe $900,000, including principal and interest, in one year. There is 60% chance a boom will occur, and only 40% chance a bust will occur.
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.
Part 3: Case Paper
Submit a written report that that responds to questions 1–3 (include all calculations as attachments or exhibits). The report should be is 1–2 pages in length, well written with introductory and concluding paragraphs, formatted as follows: double-spaced, one-inch margins, using a 12-point Times New Roman font. References must be appropriately cited as per the APA (6th Edition) citation guidelines. Include a complete bibliography.
Solution Preview
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) $1,500,000 $1,000,000
Cash flow (bust) $400,000 $500,000
The company currently has no debt but is considering borrowing $870,000 on a short-term basis to help finance its purchase of the project. The company will owe $900,000, including principal and interest, in one year.
(557 words)