e suppose that there is a bankruptcy cost of 30m what is the market price of the junior debt 344

E suppose that there is a bankruptcy cost of 30m what is the...

Transcript

00:01 In this problem we are told that cliff corp is a relatively risky firm that will have assets worth next year either 100 120 or 330 million dollars with equal probability and for the senior bond we have face value given by 95 million dollars and cost of debt equal to 4 % from here first we will calculate the interest expense which is equal to cost of debt that is 4 % or 0 .04 multiplied by face value that is 95 million dollars and that is equal to 3 million eight hundred dollars eight hundred thousand dollars and from here we will calculate the current value of senior that which is given by c multiplied by one minus one divided by one plus r raised to the power n divided by r plus face value divided by a worth plus r raised to the power n here capital c is there interest expense or coupon or r is rate and n is time period so for time period one year for n equal to 1 we have current value let's know that by v equal to 3 .8 million multiplied by 1 minus 1 divided by 1 .04 divided by 1 .0 4 divided by 1 sorry 0 .04 plus fv that is the face value and it is equal to 95 million divided by 1 .04 and on simplifying this we get its value equal to 95 million dollars itself after simplifying and similarly we will find the current value for junior debt whose face value is 30 million dollars rate is 12 percent so here the interest expense denoted by c is given by multiplying fv and r that means 0 .0 sorry 0 .1 multiplied by 30 million and from here we have the interest expense equal to 3 .6 million dollars and again here we will find the current value using the same formula that we use to find the current value of senior bond this formula so here we get the current value given by c that is 3 0 .6 million multiplied by 1 minus 1 divided by 1 .12 raised to the power 1 that is 1 .1 to itself here we're calculating for n equal to 1 and divided by 0 .12 plus 30 million divided by 1 .12 divided by 1 .12 from here the value of the junior bond is equal to 30 million dollars itself.

03:31 Now next we will find the expected value of asset let's know that by capital e is given by even multiplied by p1 e2 multiplied by p2 plus e3 multiplied by p3 here even e2 and e3 are expected value 1 2 and 3 respectively and p 1 p2 p3 as the probability of the expected value of 1 2 and 3 respectively and from the question statement we have e 1 equal to 100 million multiplied by p one because it is the equal probability for all the three expected values so here we have p1 equal to one divided by three plus e2 that is 120 million multiplied by one divided by three plus 330 million that is the expected value three multiplied by one divided by three and from here we get the value of asset equal to 183 .3 .3 million dollars after simplifying and now we will find net equity which is given by value of asset that is denoted by capital e minus value of debt so from here in the next step we get 183 .3 million dollars minus 125 million dollars and so we get the net equity equal to 58 .33 million dollars so this is a net equity and here it is the current value of senior debt and here it is the current value of junior debt in dollars now for the next part we have to find the expected return which is given by multiplying net equity with required rate of return required rate of return so thus we get the expected return given by multiplying net equity that we found out to be $58 .33 million multiplied by required rate of return which is given equal to 18%.

06:02 So from here we get the expected return of $10 .5 million...

Question

e. Suppose that there is a bankruptcy cost of $30m, what is the market price of the junior debt?

Question

e. Suppose that there is a bankruptcy cost of $30m, what is the market price of the junior debt?

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