Question

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

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