Brad's Robotics Incorporated will earn $60 in one year if it does well. The debtholders are promised payments of $40 in one year if the firm does well. If the firm does poorly,expected earnings in one year will be $10 and the repayment will be $5 because of the dead weight cost of bankruptcy. The probability of the firm performing poorly or well is 40%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 7%.
A) $17.76
B) $19.73
C) $32.55
D) $38.75
E) $39.04

Question

Quizplus · Accepted Answer

The correct answer is A because the bondholders will pay $17.76 for the debt. This is because the expected value of the debt is $17.76, which is calculated as follows:EV = (0.4 * $5) + (0.6 * $40) = $17.76

Brad's Robotics Incorporated Will Earn $60 in One Year If