TL Company has outstanding debt of $50 that is due in one year.However,given the financial distress costs,the debtholders will only receive $40 if the firm does well and $15 if it does poorly.The probability the firm will do well is 60 percent with the 40 percent probability assigned to poor conditions.What is the current value of the debt if the discount rate is 8 percent?
A)$27.78
B)$27.50
C)$30.00
D)$26.67
E)$28.40

Question

Quizplus · Accepted Answer

The correct answer is A because the current value of the debt is $27.78. This is calculated by taking the expected value of the debt, which is $40 * 0.6 + $15 * 0.4 = $27, and then discounting it back to the present at 8%, which is $27 / 1.08 = $27.78.

TL Company Has Outstanding Debt of $50 That Is Due