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(10 points) The CFO of CBA thinks that it is reasonable to...

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Finance

  1. (10 points)

The CFO of CBA thinks that it is reasonable to assume that EBITDA before taking out losses from liability lawsuits is normally distributed with an expected value equal to $200 million and a standard deviation equal to $50 million.

She is also willing to assume that Liability Costs has a Gamma distribution with an expected value of $20 million and a standard deviation equal to $14.1 million. A graph of the probability distribution for liability costs is below.

The debt covenant states that (EBITDA Liability Costs must be 2 times higher than interest expense. The firm has interest due in the coming year equal to $20 million.

Part 1: Would the CFO prefer to have a positive correlation between EBITDA and Liability Costs or zero correlation? Briefly explain your logic.

Part 2: Would the CFO prefer to the Gamma distribution (depicted below) or have Liability Losses that are normally distributed with the same expected value ($20 million) and standard deviation ($14.1 million)? Briefly explain your logic.

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