Question

Brad's Robotics Incorporated will earn $60 in one year if it does well. The debtholders are promised payments of $40 in one year if the firm does well. If the firm does poorly, expected earnings in one year will be $10 and the repayment will be $5 because of the dead weight cost of bankruptcy. The probability of the firm performing poorly or well is 40%. If bondholders are fully aware of these costs what will they pay for the debt?

Answer 1

pay for the debt = $17.76

Step-by-step explanation:

given data

earn = $60

debt holders payments = $40

earnings = $10

repayment = $5

probability = 40%

to find out

what will they pay for the debt

solution

we consider here interest rate on the bonds = 7%

so we now get here pay for the debt that is express as

pay for the debt = ( debt holders payments × probability + earn × repayment ) ÷ ( 1 + interest rate ) ..........................1

put here value we get

pay for the debt =
`(0.4*40+0.6*5)/((1+0.7))`

pay for the debt = $17.76