Your firm is evaluating a project that will generate the following cash flows next year with the following probabilities: Cash Flow at t=1 Probability Good Case $600M 0.75 Bad Case $200M 0.25 You have debt due in one year in the amount of $250M. In case of a default, 13% of the cash flows will be lost due to bankruptcy costs. Assume the proper discount rate for all cash flows is 14%. How much are expected bankruptcy costs today? You can either solve for expected bankruptcy costs directly, or by calculating how much less will your levered firm (V-L) be worth today compared to an unlevered firm (V-U)

Answer rating: 100% (QA)

To calculate the expected bankruptcy costs today we can follow either of the two approaches mentioned 1 Direct Calculation of Expected Bankruptcy Costs We can directly calculate the expected bankruptc... View the full answer