Party Cruises Ltd's only existing debt is in the form of a zero-coupon bond (this means it
Question:
Party Cruises Ltd's only existing debt is in the form of a zero-coupon bond (this means it does not pay any coupons; the issuer only promises to pay the face value at maturity) with $10 million face value and maturing in 1 year. Because of the current state of the global economy, however, Party Cruises Ltd is in financial distresses and faces an 80% chance of defaulting at the bond's maturity (i.e., if the market value of assets exceeds the $10 million owing on the bond). Given Party Cruises Ltd is currently trading at a share price of $3.00, what is the expected share price in 1 year (to the nearest cent) if Party Cruises Ltd is able to pay off its bond and avoid bankruptcy? Assume the cost of equity is 6.5% p.a. compounded annually and that dividends are banned under the bond covenant until the debt is due.