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Suppose a company is in financial distress
Suppose a company is in financial distress. Managers act rationally on behalf of shareholders. The company has access to a safe project with positive NPV, but the only way to finance the project is with funds from the existing shareholders. The manager decides not to undertake the project.
Explain why a rational manager can pass by a safe project that creates value. If you allow this project to be funded with resources from new equityholders or new debtholders, is there any possibility the project might be undertaken? Explain your answer.
Expert Solution
Rational manager generally work for better return of existing shareholders so due to this reason they only invest in a project which has positive NPV and finance for the project is available with only fund of existing shareholders.That means rational manager does not want to invest in project considering issueing of new shares or debenture financing.
By considering equity or debf financing the project might be undertaken if from such fund cost of capital is less and cashflow inflow is more generated for such funding.So that the present value of Cashinflow is more than initial cashoutflow.So its generate positive NPV and project is undertaken.
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