A firm has 60% probability of being worth $100 million and a 40% probability of being worth $150 million. There is one bond outstanding that promises to pay $100 million at an interest rate of 4%. The cost of capital for the firm's projects is 8%.
-Refer to the information above. What is the expected payoff on the bond?

Question

Quizplus · Accepted Answer

The bond will be fully paid if the firm is worth $100 million or more. Since the firm has a 60% probability of being worth $100 million and a 40% probability of being worth $150 million, the bond will be paid in full in both scenarios. Therefore, the expected payoff on the bond is $100 million.

A Firm Has 60% Probability of Being Worth $100 Million