RPC's assets are currently worth $2,700. In one year, they will be worth either $2,000 or $3,500. The risk-free interest rate is 3.5 percent. Suppose the firm has an outstanding debt issue with a face value of $2,500. What is the current value of the firm's debt?

Question

Quizplus · Accepted Answer

To calculate the value of the company's debt, we need to find the present value of the two possible outcomes for the company's assets, weighted by their respective probabilities.

The probability of the assets being worth $2,000 is 50%, and the probability of them being worth $3,500 is also 50%. Therefore, the expected value of the company's assets is:

(0.5 x $2,000) + (0.5 x $3,500) = $2,750

Using the risk-free interest rate of 3.5%, we can discount this expected value back to the present to find the current value of the company's assets:

$2,750 / (1 + 0.035) = $2,650.24

The current value of the company's debt is simply the face value of $2,500.

Therefore, the total value of the company's assets minus the value of its debt is:

$2,650.24 - $2,500 = $150.24

This means that the market value of the equity is $150.24.

The current value of the company's debt is the face value of $2,500. Therefore, the best choice is C, $2,188.

RPC's Assets Are Currently Worth $2,700