Question

Big Ed's Electrical has a pure discount bond that comes due in one year and has a face value of $1,000. The risk-free rate of return is 4 percent. The assets of Big Ed's are expected to be worth either $800 or $1,300 in one year. Currently, these assets are worth $1,140. What is the current value of the debt of Big Ed's Electrical?

$222.46

$370.77

$514.28

$769.23

$917.54

Answer 1

Present valuerf = Assets of Big Ed's are expected to be worth / ( 1 + risk free return )

= 800 / ( 1 + 0.04)

= 800 / 1.04

= $769.23

Number of options needed = ( difference between expected vaue of two assets) / ( higher expected    value of asset - face value of asset) - 0))    = (1300 - 800) / ( 300 - 0)

= 500 / 300

= 1.6667

$ 1140 = ( number of option needed * C0 ) +Present valuerf

$1140 = (1.6667 * C0 ) + 769.23

C0 = (1140 - 769.23 ) / 1.6667

= 370.77 / 1.6667

= $222.4575

Value of debt = Current worth of assets - C0

= 1140 - 222.4575

= $ 917.5425

The correct answer is option E, $917.54