Reference no: EM131190655
Sara is the founder and CEO of Deli Restaurants, Inc., a regional company. Sara is considering opening several new restaurants. Pete Thomas, the company's CFO, has been put in charge of the capital budgeting analysis. He has examined the potential for the company's expansion and determined that the success of the new restaurants will depend critically on the state of the economy over the next few years. Deli Restaurants currently has a bond issue outstanding with a face value of $34 million that is due in one year. Covenants associated with this bond issue prohibit the issuance of any additional debt. This restriction means that the expansion will be entirely financed with equity at a cost of $8.4 million. Pete Thomas has summarized his analysis in the following table, which shows the value of the company in each state of the economy next year, both with and without expansion:
Economic Growth Probability Without Expansion With Expansion
Low 0.3 $30,000,000 $ 33,000,000
Normal 0.5 $35,000,000 $46,000,000
High 0.2 $51,000,000 $64,000,000
a) Recommend the expected value of the company within one year, with and without expansion and justify whether the company's stockholders be better off with or without the expansion.
b) Assess the expected value of the company's debt in one year, with and without the expansion.
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