Gingle Co. issued 2 different zero-coupon bonds. Bond A is a junior bond with fa

Question

Gingle Co. issued 2 different zero-coupon bonds. Bond A is a junior bond with face value $87 million while Bond B is a senior bond with face value $200 million. The maturity of the debt is 1 year from now. In one year the company can be in a good state and have an asset value of $500 million, or the company can be in a bad state and have assets worth only $200 million. The two states can occur with equal probability. In case of bankruptcy, the bankruptcy costs are $30 million. The market risk premium is 5.00% and the risk-free rate is 3.00% and both bonds bear no systematic risk.

What is the market value of debt?

Explanation / Answer

Expected value of asset after one year = 50% * $500 million + 50% * $200 million

= $350 million

In case of bankruptcy, the asset value = $350 million - $30 million

= $320 million

Now, combined value of the bonds = $200 million + $87 million

= $287 million

Since, the expected value of the asset is greater than the face value of the bonds, therefore, the market value of the bond today = $287 million / (1+3%)

= $278.64 million

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

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