In general, how is the increase in the value of the firm produced by a positive
ID: 2710670 • Letter: I
Question
In general, how is the increase in the value of the firm produced by a positive net present value project distributed between the firm’s creditors and shareholders?
a. The creditors receive their interest payments from the project and shareholders have the residual.
b. The increase in value is distributed proportionately between creditors and shareholders based on the relative proportions of their holdings in the firm.
c. The total positive net present value of the project accrues to shareholders.
d. The total positive net present value of the project accrues to creditors.
Explanation / Answer
Answer: Option-A - The creditors receive their interest payments from the project and shareholders have the residual.
Explanation:
The NPV of a project is calculated in the perspective of entire firm, using the required rate of return for the firm/project as discount rate. So the NPV accrues first to creditors and then shareholders shareholders as it happens in any normal business.