The current value of a firm is $1,400. The firm has $1,000 in pure discount debt due in one year and the risk-free rate is 6%. The firm's assets will be worth either $1,200 or $1,500 in one year. What is the current value of the firm's debt?

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Quizplus · Accepted Answer

The current value of the firm's debt can be calculated by discounting the expected debt payoff at the risk-free rate. The expected debt payoff is the minimum of the debt value ($1,000) and the firm's future value in both states ($1,200 and $1,500, both of which are higher than $1,000, so the full $1,000 will be paid back). Thus, the expected debt payoff is $1,000. Discounting this at the risk-free rate of 6% gives the present value of the debt: $1,000 / (1 + 0.06) = $943.396, which rounds to $943.

The Current Value of a Firm Is $1,400