Question

Big Ed's Electrical has a pure discount bond that comes due in one year and has a face value of $1,000. The risk-free rate of return is 4 percent. The assets of Big Ed's are expected to be worth either $800 or $1,300 in one year. Currently, these assets are worth $1,140. What is the current value of the debt of Big Ed's Electrical?
a) $222.46
b) $370.77
c) $514.28
d) $769.23
e) $917.54

Answer 1

Answer: $917.54

Explanation:

The current value of the debt of Big Ed's Electrical will be calculated thus:

First, we will calculate the present value which will be:

= $800 / (1 + 4%)

= $800 / ( 1 + 0.04)

= 800 / 1.04

= $769.23

The number of options that are needed

will be:

= (1300 - 800) / ( 300 - 0)

= 500 / 300

= 1.6667

Therefore,

1140 = ( number of option needed × Co) + Present value

1140 = (1.6667 × Co ) + 769.23

Co = (1140 - 769.23 ) / 1.6667

Co = 370.77 / 1.6667

Co = $222.46

Value of debt will now be:

= Current worth of assets - Co

= 1140 - 222.46

= 917.54

Therefore, the answer is $917.54