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?

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Business

Fiona Clark

28 July, 20:35

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?

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Immanuel Hill · Answer 1

The minimum fraction is 80%

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.