Mckenzie Corporation

McKenzie Corporation’s Capital Budgeting

July 4, 2011

McKenzie Corporation‘s Capital Budgeting

1. What is the expected value of the company in one year, with and without expansion? Would the company’s stockholders be better off with or without expansion? Why?

Expected value with expansion =E(value of company)=P(Low)*V(Low)+P(Normal)*V(Normal)+ P(High)*V(High)

=0.3*13+0.5*24+0.2*28.5

= $21.6 million

Expected value of the company w/out expansion =E(value of company)=P(Low)*V(Low)+ P(Normal)*V(Normal)+P(High)*V(High)

= .30*11,000,000 + .50*17,500,000 + .20*22,500,000

Based on the calculations above the stockholders would be better off with an expansion. It would increase the value of the company and their profits.

2. What is the expected value of the company’s debt in one year, with and without the expansion?

Debt of Company-$14 million

The expected value of debt without the expansion is .30*14 + .50*14 + .20*14 = $14 million.

The debt does not change since the expansion is fully funded by the equity. The expected value of debt with the expansion will remain the same.

3. One year from now, how much value creation is expected from the expansion? How much value is expected for stockholders? Bondholders?

The expected value of the company with the expansion is $21.6 million.

The expected value of the company w/o the expansion is $16.55 million.

Change in expected value due to the expansion is $5.05 million ($21.6-$16.55=$5.05).

$5.05million less $4.5million of equity=$0.55million net value.

There is no change in the level of debt because the expansion was funded by equity.

The expected value for the stockholder is $0.55 million.

The expected value for bondholders is $0.

4. If the company announces that it is not expanding, what do you think will happen to the price of its bonds? What will happen to the price of bonds if the company does expand?

If the company does not expand there will be no change in the...