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Mr.Keith Jones is the manager of State of the Art, Inc.The firm has two kinds of debt: senior debt of $500, and junior debt bank loan) of $1,500.The firm has an asset with a liquidation value of $700.If the firm continues to operate, its asset can generate $1,750 with probability
0.8 and zero with probability 0.2.Mr.Jones suffers a personal cost of $25 from managing the firm for another period.Mr.Jones is the sole equity holder of the firm.
-If the firm continues for another period, what would be the bank's net expected payoff?

Question

Use the following information for questions 
Mr.Keith Jones is the manager of State of the Art, Inc.The firm has two kinds of debt: senior debt of $500, and junior debt bank loan) of $1,500.The firm has an asset with a liquidation value of $700.If the firm continues to operate, its asset can generate $1,750 with probability
0.8 and zero with probability 0.2.Mr.Jones suffers a personal cost of $25 from managing the firm for another period.Mr.Jones is the sole equity holder of the firm.
-If the firm continues for another period, what would be the bank's net expected payoff?

Quizplus · Accepted Answer

The bank's net expected payoff is calculated by considering the probability of the firm generating $1,750. With an 80% chance, the firm will generate $1,750, and the bank will receive the remaining amount after the senior debt of $500 is paid, which is $1,250. With a 20% chance, the firm generates $0, and the bank receives nothing. Thus, the expected payoff is 0.8 * $1,250 + 0.2 * $0 = $1,000.

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