A Firm Is Worth $50 or $180 with Equal Probability

question 22

Multiple Choice

A firm is worth $50 or $180 with equal probability and is financed with debt that has a face value of
$60. The cost of capital for all securities is 12%. If the firm issues new debt with a face value of
$40 that has the same priority as the $60 debt being sold today, what effect will it have on the
Value of the existing debt?

• A)The value of the existing debt will increase, but the amount of risk shared by the new bondholders must be known in order to calculate the exact amount of the increase.
• B)The value of the existing debt will decrease $8.93.
• C)There will be no effect on the value of the existing debt.
• D)The value of the existing debt will increase $26.79.

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Definitions:

Classically Conditioned Fear

A learned response to a previously neutral stimulus that becomes associated with a negative event, leading to fear responses to the stimulus.

Iconic

Describing something or someone as highly recognizable, widely known, and regarded as a symbol of a particular era, genre, or field.

Explicit Memories

Memories that can be consciously recalled, such as facts and events, part of declarative memory.

Effortful Processing

Effortful processing is a type of memory encoding that requires awareness, attention, and effort to encode information.