A company’s asset is worth 20 now, and will be worth 16 (in the bad state) or 24 (in the good state) with equal probabilities tomorrow. The riskfree interest rate is 10%. The company lives for only one period. It promises to repay 18 to the debtholders next period.
What is the value of debt?
What is the expected yield of the debt? How does it compare with the riskfree rate?
What is the value of equity?
Suppose the company receives a government loan guarantee. What is the loan guarantee worth? What is the value of the company after it receives the loan guarantee? Why is the company worth more?
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