Finance Question: Good-Time Company is a regional chain department store. It wil

Question

Finance 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 64 percent and the probability of a recession is 36 percent. It is projected that the company will generate a total cash flow of $212 million in a boom year and $80 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 $87 million. The company pays no taxes.

Question 1:

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

Expected Payoff $___________

Question 2:

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

Promised Return____________%

Question 3:

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

Expected Return____________%

Explanation / Answer

Expected cash flows = 64% * 212 + 36%* 80 = $164.48 million

As expected cash flows = $164.48 million > Debt payment = $121 million, expected payoff = $121 million --------(1)

Question 1:
In the event of recession, cash flows = $80 million.

As the firm cannot pay more than its cash flow, Expected payoff = $80 million

Question 2:

Promised return = (Promised payoff/Market value) - 1 = (121/87) -1 = 39.08%

Question 3:

I am not sure if you wanted expected return overall, or in case of a recession.

Overall expected return = Promised return = 39.08% as Expected cash flows = Promised cash flows = $121 million from (1)

Expected return in case of recession = (80/87)-1 = -8.05%

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