Company X has the following market value balance sheet:
Cash $5 $25 Bonds outstanding
Net Working Capital $15 $5 Common stock
PV of future CFs $10
Who is likely to gain and who is likely to lose from the following maneuvers? (Assume that the risk-free rate is zero. Also, suppose that the debt is risky). You may want to (but are not required to) use numerical examples to support your conclusions.
a. Company X pays a cash dividend of $5 to its shareholders.
b. Company X halts operations, sells its fixed assets, and converts net working capital into $15 cash. Unfortunately the fixed assets fetch only $6 on the second-hand capital goods market.
The $26 cash is invested in Treasury Bills. (Here you can think of fixed assets as machinery that would produce future cash flows with PV=$10 if the firm kept operating. Since the fixed assets are sold, these future cash flows will not be realized now).