Waco Manufacturing Company has a cash (and marketable securities) balance of $150 million. Free cash flows during a projected 1-year recession are expected to be $200 million with a standard deviation of $200 million. (Assume that free cash flows are approximately normally distributed.)
a. Determine the probability that Waco will run out of cash during the recession.
b. Waco is considering a change in its capital structure that would add $50 million (after-tax) to its fixed financial charges. Determine the probability of running out of cash if the change in capital structure is undertaken.
c. Determine the maximum additional fixed financial charges that Waco can incur if it is willing to tolerate only a 5 percent chance of running out of cash during the recession.