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understand why the debt value for outcome 3 and 4 has to be multiplied by 0.25 of their respective cash flow.  And how come it is not ourcome 1 and outcome 2 to be multiplied for the bankruptcy cost

understand why the debt value for outcome 3 and 4 has to be multiplied by 0.25 of their respective cash flow.  And how come it is not ourcome 1 and outcome 2 to be multiplied for the bankruptcy cost

FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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I dont understand why the debt value for outcome 3 and 4 has to be multiplied by 0.25 of their respective cash flow. 

And how come it is not ourcome 1 and outcome 2 to be multiplied for the bankruptcy cost 

M Inbox (171) 17 CADCHF 0. K Course: 50C X Does Debt x O Advanced O Corporate F X G DEVT VALU X Email - Leur x Elite march March 202 Facebook (17) YouTub x 30 Discord + A keats.kcl.ac.uk/pluginfile.php/8014280/mod_resource/content/1/5QQMN533%20T3%20Equity%20Capital%20and%20Debt%20Financing%20Solutions.pdf Corporate Finance 3 / 26 + | 100% Question 1 • KBS Corporation is about to launch a new product. Depending on the success of the £150 million, £135 million, £95 million, and £80 million. These outcomes are all equally likely, and this risk is diversifiable. The risk-free rate is 5%. KBS has debt with a face value of £100 million due next year. w product, KBS may have one of four values next year: Suppose that, in the event of default, 25% of the value of KBS's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.) 3 Question 1a – Debt value 1:11 AM P Type here to search Raining now E O a )) ENG 3/6/2022 11 > II
Transcribed Image Text:M Inbox (171) 17 CADCHF 0. K Course: 50C X Does Debt x O Advanced O Corporate F X G DEVT VALU X Email - Leur x Elite march March 202 Facebook (17) YouTub x 30 Discord + A keats.kcl.ac.uk/pluginfile.php/8014280/mod_resource/content/1/5QQMN533%20T3%20Equity%20Capital%20and%20Debt%20Financing%20Solutions.pdf Corporate Finance 3 / 26 + | 100% Question 1 • KBS Corporation is about to launch a new product. Depending on the success of the £150 million, £135 million, £95 million, and £80 million. These outcomes are all equally likely, and this risk is diversifiable. The risk-free rate is 5%. KBS has debt with a face value of £100 million due next year. w product, KBS may have one of four values next year: Suppose that, in the event of default, 25% of the value of KBS's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.) 3 Question 1a – Debt value 1:11 AM P Type here to search Raining now E O a )) ENG 3/6/2022 11 > II
M Inbox (171) 17 CADCHF 0. K Course: 50C X Does Debt x O Advanced O Corporate F X G DEVT VALU X Email - Leur x Elite march March 202 Facebook (17) YouTub x 30 Discord + A keats.kcl.ac.uk/pluginfile.php/8014280/mod_resource/content/1/5QQMN533%20T3%20Equity%20Capital%20and%20Debt%20Financing%20Solutions.pdf Corporate Finance 4 / 26 100% + | 3 Question 1a – Debt value a) What is the initial value of KBS's debt? Outcome 1 Outcome 2 Outcome 3 Outcome 4 Cash flows £150m £135m £95m £80m Debt value £100m £100m £71.25m =95x(1- 25%) £60m Equity Value £50m £35m Probability 25% 25% 25% 25% Bankruptcy costs = Direct (e.g., legal fees), Indirect (losing customers, suppliers, talented employees) 100*0.25+100*0.25+71.25*0.25+60*0.25 → The initial value of debt : = £78.87m 1+5% 1:11 AM P Type here to search Raining now E O a )) ENG 3/6/2022 11 > 国 近 II
Transcribed Image Text:M Inbox (171) 17 CADCHF 0. K Course: 50C X Does Debt x O Advanced O Corporate F X G DEVT VALU X Email - Leur x Elite march March 202 Facebook (17) YouTub x 30 Discord + A keats.kcl.ac.uk/pluginfile.php/8014280/mod_resource/content/1/5QQMN533%20T3%20Equity%20Capital%20and%20Debt%20Financing%20Solutions.pdf Corporate Finance 4 / 26 100% + | 3 Question 1a – Debt value a) What is the initial value of KBS's debt? Outcome 1 Outcome 2 Outcome 3 Outcome 4 Cash flows £150m £135m £95m £80m Debt value £100m £100m £71.25m =95x(1- 25%) £60m Equity Value £50m £35m Probability 25% 25% 25% 25% Bankruptcy costs = Direct (e.g., legal fees), Indirect (losing customers, suppliers, talented employees) 100*0.25+100*0.25+71.25*0.25+60*0.25 → The initial value of debt : = £78.87m 1+5% 1:11 AM P Type here to search Raining now E O a )) ENG 3/6/2022 11 > 国 近 II
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