Good Time Company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 percent and the probability of a recession is 40 percent. It is projected that the company will generate a total cash flow of $185 million in a boom year and $76 million in a recession. The company’s required debt payment at the end of the year is $110 million. The market value of the company’s outstanding debt is $83 million. The company pays no taxes.
a. What payoff do bondholders expect to receive in the event of a recession?
b. What is the promised return on the company’s debt?
c. What is the expected return on the company’s debt?