Question about Financial distress
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Good time company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 percent and the probability of a recession is 40 percent. It is projected that the company will generate a total cash flow of 250MM in a boom year and 100MM in a recession. The company's required debt payment at the end of the year is 150MM. The MV of the company's outstanding debt is $108.93 MM. The company pays no taxes. Assume a discount rate of 12 percent.
A. What payoff do bondholders expect to receive in the event of a recession?
B. What is the promised return on the company's debt?
C. What is the expected return on the company's debt?
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Solution Summary
The solution explains the payoff to bond holders in the event of a financial distress
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A. What payoff do bondholders expect to receive in the event of a recession?
The market value of a firm's debt is the present value of expected cash flow to the firm's debt holders. The market value of debt is given as $108.93 million which is the present value of expected cash flow to the firm's debt holders. In the event of a boom, the bondholders will get the promised $150 million. Let X be the amount that bondholders expect to receive in the event of a ...
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