Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 15 C-1
CHAPTER 15
DUGAN CORPORATION’S CAPITAL
BUDGETING
1. We assume the $3.7 million is spent at the start of the year so we can ignore time value of money
considerations. If we include the time value of money, the numerical solutions will change slightly,
but the analysis will remain the same. The expected value of the company in one year without
expansion is:
V = .30($7,900,000) + .50($13,000,000,000) + .20($17,000,000)
V = $12,270,000
And the expected value of the company in one year with expansion is:
2. The value of the company’s debt with low economic growth is the value of the company because the
company value is less than the face value of the debt. In both other economic states, the value of the
debt is the face value of the debt. So, the expected value of debt in one year without expansion is:
B = .30($7,900,000) + .50($10,300,000) + .20($10,300,000)
And the value of the company’s debt in one year with expansion is:
B = $10,060,000
3. The value of the company’s equity with low economic growth is zero both with and without expansion
since the company value will be less than the face value of the debt. The value of equity with normal growth
or high growth is the value of the company minus the $10.3 million face value of debt. So, the expected
value of the equity without expansion is:
S = .30($0) + .50($2,700,000) + .20($6,700,000)
S = $2,690,000
And the value of equity with expansion is:
CHAPTER 15 C-2
4. Assuming bondholders are fully informed and they act rationally, they will expect the stockholders to
5. If they don’t expand, nothing will happen since it is already priced into the bond. If the company
6. It is a stronger signal that stockholders are not acting in their best interest if the expansion is financed
with cash on hand. If the company issues new equity, the expected loss in stock value is shared
in stock value.
