Johnson International is an all equity firm with a current market value of $50 m
ID: 2707345 • Letter: J
Question
Johnson International is an all equity firm with a current market value of $50 million dollars. The firm has a .75 probability of having a value of $80 million at the end of one year and a .25 probability of having a value of zero. The current yield for risk free zero coupon bonds having one year to maturity is 5 percent. Johnson is planning to recapitalize the firm by issuing risky zero coupon bonds that promise bondholders a payment of $21 million at the end of one year. Assuming that there are no corporate or personal taxes, determine
Explanation / Answer
a)
Value Currently 50 Value at the end of One Year 0.75*80 + .25*0 60 Required Return on Assets 20.0% (60-50)/50 b)
Market Value of Risk Free Debt 21 Million / (1+5%) >> 5% which is the rate of return on the Risk Free ZC Bond Market Value of Risk Free Debt 20.0
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