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Memphic Memphic
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Posts: 728
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6 years ago
If Nielson Motors invests in only those projects which are beneficial to the stockholders, then the total debt overhang associated with accepting these project(s) is closest to:
A) $22.5 million
B) $36.0 million
C) $38.0 million
D) $57.5 million
Textbook 
Corporate Finance: The Core

Corporate Finance: The Core


Edition: 4th
Authors:
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Replies
wrote...
6 years ago
B
Explanation:  B) Equity holders will benefit from the new investment only when:
PI >   ×   =   × 1.8 = 0.125 × 1.8 = .225
Project   1   2   3   4   5
Investment   100   75   120   60   80
NPV   23   12   18   15   14
               
PI(NPV/Invest)   0.23   0.16   0.15   0.25   0.175

Given the PIs above, only projects 1 and 4 are greater than .225.
since PI =  , then .225 =   
   → NPV = 22.5 million total debt overhang for project 1
since PI =  , then .225 =   
   → NPV = 13.5 million total debt overhang for project 4
Total debt overhang = 22.5 + 13.5 = 36.0 million
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