TL Company Has Expected Earnings of $75 in One Year

question 32

Multiple Choice

TL Company has expected earnings of $75 in one year if it does well and $25 if it does poorly. The firm has outstanding debt of $50 that is due in one year. However, given the financial distress costs, the debtholders will only receive $40 in one year if the firm does well and $15 if it does poorly. There is a 60 percent chance the firm will do well and a 40 percent chance that it will do poorly. What is the current value of the debt if the interest rate on bonds is 8 percent?

• A) $27.78
• B) $27.50
• C) $30.00
• D) $26.67
• E) $28.40