Question: 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

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	$100M	0.25

You have debt due in one year in the amount of $250M. In case of a default, 16% of the cash flows will be lost due to bankruptcy costs. Assume the proper discount rate for all cash flows is 12%. 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 (Vl) be worth today compared to an unlevered firm (Vu)?

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