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f) Bond holders get 50 if sunshine and 10 if rain. PV(bond) = 30, PV(equity) = 30.
Returns: bond = plus or minus 67%, equity = plus or minus 100%. This reorganization
transfers value from bond holders to equity holders. Note that the total value of the firm
is still bond + equity = 60. Equity holders have a lot to gain from this, at the expense of
Bottom line: equity holders like volatile cash flows because they get the upside and none
of the downside. The opposite happens with less volatile cash flows: they benefit bond
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This document was uploaded on 02/27/2014 for the course ECON 1745 at Harvard.
- Fall '08