Acme Industries is trying to place a new product. If it is a hit, its cash flows at the end of the year will be $100 million. If it fails, cash flows will be $20 million. They have issued debt with $50 million due at the end of the year. Furthermore, they know that in the event of bankruptcy there would be no cost of financial distress (perfect capital markets). If they default, all the assets will be transferred to bondholders at the fair market value. The risk-free rate is 5% and the risk premium for Acme is 5%. Their probability of success is 50%.

b) What are the cash flows available to all investors if the firm fails?

Answer rating: 100% (QA)

To calculate the cash flows available to all investors if the firm fails we need to consider the sce... View the full answer