Question

Sunlife Company has a $18,000 pure discount bond that comes due in one year. The risk-free rate of return is 3 percent. The firm's assets are expected to be worth either $16,000 or $21,000 in one year. Currently, these assets are worth $19,000. What is the current value of the firm's debt? $15,807.64 $16,920.39 $16,454.78 $15,398.20 $17,530.66

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

ANSWER : $16920.39

DERIVATIVES BINOMIAL - Microsoft Excel (Product Activation Failed) View Add-Ins - 2x Dr General File Home Insert Page Layout Formulas Data Review % Cut Calibri -11AA = = = Ea Copy Paste Format Painter BI U D A Clipboard Font Wrap Text Merge & Center - $ -% -28.9 Conditional Format Formatting as Table Styles Cell Styles Insert Delete Format Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Alignment Number Cells A457 Α B F G H 457 458 PRICE DECREASE = PRICE INCREASE = (16000-19000)/19000 (21000-19000)/19000 -15.7895% 10.5263% 459 460 461 462 463 PAYOFF IF PRICE INCREASE = IF PRICE DECREASE = MAX [21000-18000, 0] = MAX (16000 - 18000, 0] = 3000.00 0.00 464 465 466 467 468 469 470 NOW TO GET 3% RETURN WE CAN USE FOLLOWING EQUATION TO FIND RISK NEUTRAL RPROBABILITY RISK FREE RATE = PROB(INCREASE)*(36%) + PROB(DECREASE)(-12%) 3%= (X)(10.5263%) +(1-x)(-15.7895%) 3%= (X)(10.5263%) -15.7895% +(X)(15.7895%) 18.7895% = (X)(26.3158%) X= 0.7140 PROBABILITY OF INCREASE 1-X = 0.2860 PROBABILITY OF DECREASE 471 472 473 474 475 NE Rea BINOMIAL ferences BS Sheet2 RISK NEUTRAL Sheet3 Sheet4 Sheets Sheet6 Sheet7 BO 130% _ 0 + DOR . * 4 OENG 04-11-2019

DERIVATIVES BINOMIAL - Microsoft Excel (Product Activation Failed) View Add-Ins File Home Insert Page Layout Formulas Data Review - 2x % Cut Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Calibri -11AA = = = Dr Wrap Text General E Copy Paste B I U - D E A E E s FMerce Merge & Center Center Format Painter $ - % % 4.0 .00 8.9 Conditional Format Cell Insert Delete Format Formatting as Table Styles Clipboard Font Alignment Number Styles Cells A493 A B DE H 475 476 THEREFORE VALUE OF EQUITY = 477 EXPECTED PAYOFF = (PROB(INCREASE) * PAYOFF + PROB(DECREASE) *PAYOFF)/(1+RISK FREE RATE) 478 EXPECTED PAYOFF = ((0.7140*3000) + (0.2860*0))/(1+0.03) 479 EXPECTED PAYOFF = 2079.61 480 481 ANSWER VALUE OF DEBT = 16920.39 (19000 - 2079.61] [ VALUE OF ASSETS TODAY - VALUE OF EQUITY] 483 484 485 486 482 487 488 489 490 491 492 493 BS Sheet2 RISK NEUTRAL Sheet3 Sheet4 Sheets Sheet6 Sheet7 K Rea BINOMIAL ferences BO 130% _ 0 + 04-11-2019