Since M&M state that capital structure does not affect total firm value
(at least not until we take into account taxes and financial distress
costs), the $30M decline in the value of the old debt has to go to the
equity holders.
Note that the text has an error in part b, it should be "$60M". The key
thing to note here is that the stockholders who sell their shares will
not be willing to sell it at the OLD price of $10. Their shares are
worth 10 + 30M/15M =12 just after the debt is issued, so that's what
they need to receive, $12 per share - hence the 5 million share answer.
> -----Original Message-----
> From: Brian Viscusi [SMTP:bri627@hotmail.com]
> Sent: Thursday, August 27, 1998 1:23 PM
> To: studygroup5b@lists.casact.org
> Subject: Chapter 17, Quiz #11
>
> In quiz question # 11 of chapter 17 on page 470 it says, "Debtholders,
>
> seeing the extra risk, mark the value of the existing debt down to $70
>
> million."
>
> Why would this haapen? Is it a common occurence? I really don't
> follow
> the logic. Since it is known that there is going to be more debt
> issued, why lower the current amount of debt? Wouldn't this make the
> equity less risky for no reason at all prior to the extra debt being
> issued.
>
> I can answer the questions to this problem, but I just don't
> understand
> why or how "marking the value of the debt" down occurs? Any insight
> on
> this problem would be appreciated.
>
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