Problem: Bankruptcy costs calculation?
equity value in two years can be $25 million with a 50% probability, or $12 million with probability 50%. The bond is a zero-coupon bond with face value $15 million. Everyone is risk-neutral, and the risk-free rate is 5%. The market price of the bond is 75% of the face value. Assume perfect capital markets and no taxation.A company has an outstanding bond that will mature in two years. After two years the company will terminate all activity. The company unleveredWhat is the value of bankruptcy costs at year two?
The correct answer is 2.19 million.
I have absolutely no clue how they would come up with that answer. I just don't see any logic with the expected values of the equity and the loss of debtors. Can someone please lead me through this calculation?
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