Question

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 80 percent and the probability of a recession is 20 percent. It is projected that the company will generate a total cash flow of $192 million in a boom year and $83 million in a recession. The company's required debt payment at the end of the year is $117 million. The market value of the company’s outstanding debt is $90 million. The company pays no taxes.

a. What payoff do bondholders expect to receive in the event of a recession? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
Payoff $
b. What is the promised return on the company's debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Promised return %
c. What is the expected return on the company's debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Expected return %

Answer 1

a. The payoff do bonholders expect to receive in the event of a recession=$83 million

b. The promised return is 0.30

c. The expected return is -16%

Step-by-step explanation:

a. According to the given data the payoff do bonholders expect to receive in the event of a recession=$83 million

b. In order to calculate the promised return on the company's debt we would have to use the following formula:

promised return=(face value of debt/market value of debt)-1

promised return=($117 million/$90 million)-1

promised return=0.30

c. To calculate the expected return on the company's debt we would have to use the following formula:

expected vale of debt=($117*80%)+($90*20%=

=75.6 million

expected return=(75.6 million/$90 million)-1

expected return=-16%