Sludge Corporation has two bonds outstanding, each with a face value of $2.70 mi

Question

Sludge Corporation has two bonds outstanding, each with a face value of $2.70 million. Bond A is a senior bond; bond B is subordinated. Sludge has suffered a severe downturn in demand, and its assets are now worth only $4.40 million. If the company defaults, what payoff can the holders of bond B expect?

Sludge Corporation has two bonds outstanding, each with a face value of $2.70 million. Bond A is a senior bond; bond B is subordinated. Sludge has suffered a severe downturn in demand, and its assets are now worth only $4.40 million. If the company defaults, what payoff can the holders of bond B expect?

Explanation / Answer

Calculation of Payoff for bond B:

Total worth of assets to pay off bonds =$4.40 Million

Less: Pay off to senior Bond A = $2.70 Million

Pay Available for Subordinate bond A = 4.40 -2.70 = $1.70 Million

Value of Bond A = $2.70 Million

Hence payoff Expected = 1.70 / 2.70 = 0.6296 = 62.96%

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