TL Company has expected earnings of $75 in one year if it does well and $25 if it does poorly. The firm has outstanding debt of $50 that is due in one year. However, given the financial distress costs, the debtholders will only receive $40 in one year if the firm does well and $15 if it does poorly. There is a 60 percent chance the firm will do well and a 40 percent chance that it will do poorly. What is the current value of the debt if the interest rate on bonds is 8 percent

Question

Business

Ward

12 June, 04:47

TL Company has expected earnings of $75 in one year if it does well and $25 if it does poorly. The firm has outstanding debt of $50 that is due in one year. However, given the financial distress costs, the debtholders will only receive $40 in one year if the firm does well and $15 if it does poorly. There is a 60 percent chance the firm will do well and a 40 percent chance that it will do poorly. What is the current value of the debt if the interest rate on bonds is 8 percent

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Fernanda Bailey · Answer 1

Answer:$27.78

Explanation:

Expected value of debt after one year = (40*.60) + (15*.40)

= 24 + 6

=$ 30

Current value of debt = Value at 1year / (1+r) ^n

= 30 / (1+.08) ^1

= 30 / 1.08

=$ 27.78