Chicken City is ready to launch a new product. Depending upon the success of this...
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Chicken City is ready to launch a new product. Depending upon the success of this product, it will have a value of either $100 million or $181 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy (i.e. risk from the project is diversifiable) so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume that the capital markets are perfect.
Assume that in the event of default, $15 million will be lost in bankruptcy costs and suppose that Chicken City has zero-coupon debt with a $165 million face value due next year.
The initial value of Chicken City's debt is closest to:
a.
$170 million
b.
$110 million
c.
$120 million
d.
$80 million
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