Question: GoingDown Corporation (GDC)will remain in business for one more year. The estimated probability of a boom year is 60%, status quo is 10% , and the recession is 30%. It is projected that GDC will have total cash flow of $1000 million in a boom year, $800 million in status quo, and $400 million in recession. Its required debt payment is $700 million at the year end. Assume risk neutrality and the required rate of return of 8% per year for both the stock and the bond.
- What is the total value of the firm? What is the value of the equity?
- If the total market value of the bond outstanding of GDC is $550 million, what is the expected bankruptcy cost in case of a recession?
- Continuing with part b, what is the total value of the firm now?
- What is the promised return on the bond? What is the probability?