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CHAPTER 16 C-1
CHAPTER 17
McKENZIE CORPORATION’S CAPITAL
BUDGETING
1. We assume the $5,400,000 is spent immediately 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($22,000,000) + .50($31,000,000) + .20($48,000,000)
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:
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 $26,000,000 face value of debt. So, the
expected value of the equity without expansion is:
VE = .30($0) + .50($5,000,000) + .20($22,000,000)
4. Assuming bondholders are fully informed, and they act rationally, they will expect the stockholders
5. If they don’t expand, nothing will happen since this assumption is already priced into the bond. If the
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
