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#6. Good Time Co. is a regional chain department store. It will remain in business for...

#6. Good Time Co. is a regional chain department store. It will remain in business for one more year. The estimated probability of a boom next year is .60 and the estimated probability of a recession is .40. It is projected that Good Time will have a total cash flow of $250 million in a boom year and $100 million in a recession. Good Time’s required debt repayment next year is $150 million. The firm has few fixed assets, so after next year is over the firm’s assets will be liquidated for $0. Assume also that investors are risk-neutral and that interest rates are zero (i.e., no discounting is necessary). There are no taxes. (a) Assuming that there were no financial distress costs or bankruptcy costs, calculate the market value of Good Time’s (i) equity and (ii) debt. (b) If the market value of equity is actually $60 million and the market value of debt is actually $125 million, what is the market’s estimate of financial distress/bankruptcy costs?

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Total Cash flow in boom year will be $250 million. The required debt payment next year (boom year) is $ 150 million. So, equiA B C (im millions) D = (P x C) + ( P2 x B) Payment in recession Payment | Expected Value in boom. Total Payment 100 250 (0.6Thus, market value of equity is $ 60 million $ 130 million Good and Times Debt is 16) market value of equity market value ofmarket value of Good Time. This difference is the markets estimate of financial distress / bankruptcy costs. markets estima

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