Question

Suppose Tefco Corp. has a value of ​$100100 million if it continues to​ operate, but has outstanding debt of ​$120120 million that is now due. If the firm declares​ bankruptcy, bankruptcy costs will equal ​$2020 ​million, and the remaining ​$8080 million will go to creditors. Instead of declaring​ bankruptcy, management proposes to exchange the​ firm's debt for a fraction of its equity in a workout. What is the minimum fraction of the​ firm's equity that management would need to offer to creditors for the workout to be​ successful?

Answer 1

The minimum fraction is 80%

Step-by-step explanation:

Creditors receive 80 million in bankruptcy since if there is bankruptcy, the bankruptcy cost is $20m while the other $80m is received by creditors, so they need to receive at least this much. Therefore, the minimum fraction of the​ firm's equity that management would need to offer to creditors for the workout to be​ successful is 80%. Tefco could offer its creditors 80% of the firm in a workout.