Good Time Company is a regional chain department store. It will remain in busine

Question

Good Time Company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 80 percent and the probability of a recession is 20 percent. It is projected that the company will generate a total cash flow of $196 million in a boom year and $87 million in a recession. The company's required debt payment at the end of the year is $121 million. The market value of the company’s outstanding debt is $94 million. The company pays no taxes. a. What payoff do bondholders expect to receive in the event of a recession? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g. 1,234,567).) Payoff $ b. What is the promised return on the company's debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).) Promised return % c. What is the expected return on the company's debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

a) What payoff do bondholders expect to receive in the event of a recession?

$87 million.
Reason: Total amount due on debt payment: $121 million and Good Time Company has the capacity to generate $87 million during recession. So, the total payoff to bondholders in the event of recession = $87 million.

b. What is the promised return on the company's debt?

Promised return = Face value of Debt / Market Value of Debt - 1
Face value = $121 million; Market value of debt = $87 million
Therefore, 121/87 - 1 = .3908 or 39.08%

c. What is the expected return on the company's debt?

Expected Value of debt = recession probablity * 87 + Boom Probablity * 121
Expected Value of debt = .20%*87 + 80%*121 = $114.2 million
Expected Return = Expected Value / Market Value - 1
= 114.2 / 87 - 1 = 0.3126 or 31.26%

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.