Rose Industries Has a $20 Million Loan Due at the End

question 62

Essay

Rose Industries has a $20 million loan due at the end of the year and its assets will have a market value of only $15 million when the loan comes due.Currently Rose has $2 million in cash.Rose is considering two possible alternative uses for this cash.One possibility is to pay the $2 million out to shareholders in the form of a special dividend.The second possibility is to invest the $2 million into a project that offers a $4 million NPV.What are the payoffs to the debt and equity holders under each of the two alternatives? Which alternative would equity holders prefer? Which alternative would debt holders prefer? What is the economic term that describes this situation?

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Definitions:

Environmental Protection Agency

The Environmental Protection Agency (EPA) is an agency of the U.S. federal government tasked with protecting human health and the environment by writing and enforcing regulations based on laws passed by Congress.

Medicare

A federal health insurance program in the United States for people who are 65 or older, as well as for some younger people with disabilities or specific diseases.

Young Americans For Freedom

A conservative youth organization in the United States, founded in 1960 to advocate for free market economics, limited government, and national defense.

Conservatives

Individuals or groups favoring traditional values, resistance to change, and the maintenance of established social norms and institutions.