Question

The Winning Co. is in financial trouble and it is expected that it will file for bankruptcy protection today. You hold a $1,000 face value bond of the company paying annual coupons and maturing in 10 years. After the bankruptcy filing the firm will stop paying interest and bondholders expect to receive $.25 for every $1.00 of face value in two years, one share of the reorganized company with an expected price of $50. It is also expected that at the resolution of bankruptcy in 4 years, the bondholders will receive another $0.15 for every dollar of face value. You also know that bonds with similar risk are selling at YTM of 25%. What should be the price of the bonds? Assume the cost of equity for the reorganized company to be 25%.

Answer 1

Amount recieved by bondholders in 2 years = 1000 * 0.25 = $250

Amount reccieved by bondholders in 4 years = 1000 * 0.15 = $150

Price of share recieved after 1 year = $50

Price of the bond today = discounted value of cash flows recieved on bond + discounted value of share price recieved in 2 years

= cash flow from bond in 2 years / ( 1 + ytm ) ^ 2 + cash flow recived from bond in 4 years / ( 1+ ytm )^4 + share prie / ( 1+ cost of equity)

= 250 /1.25^2 + 150/ 1.25^4 + 50/1.25^2

= 160 + 61.44 + 32

= $253.44