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)

Value of firm in recession = 87*10^6 = 87000000

required payment = 121*10^6 = 121000000

payoff = Min (87000000, 121000000) = 87000000

b)

promised return = (121 / 94) - 1 = 28.72%

c)

bonds payoff = 80%*121+ 20%*87 = 114.2

expected return = (114.2 / 94) - 1 = 21.49%

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