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 current value of the firm's debt?

Question

Quizplus · Accepted Answer

The current value of the bond can be found using the present value formula: 
PV = FV/(1+r)^t
where PV is the present value, FV is the future value, r is the interest rate, and t is the time period. 
In this case, the bond pays $100 million at an interest rate of 4%, so:
PV = $100 million/(1+0.04)^1 = $96.15 million
Therefore, the current value of the firm's debt is $96.15 million.

Note that choice C is incorrect because it only gives the face value of the bond, not the current value.

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