The Window Store will have a value of $139,000 if the economy does well this coming year and a value of $121,000 if the economy does poorly. The probability of a good economy is 68 percent. The firm owes its bondholders $63,000. The firm will only operate for one more year. What is the value of this firm to its shareholders?

Question

Giovanni

Business

7 February, 07:19

The Window Store will have a value of $139,000 if the economy does well this coming year and a value of $121,000 if the economy does poorly. The probability of a good economy is 68 percent. The firm owes its bondholders $63,000. The firm will only operate for one more year. What is the value of this firm to its shareholders?

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Answers (1)

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Marlene Coleman · Answer 1

The value of this firm to shareholders is $70240

Explanation:

Using expected value approach, the value of the firm can be computed as:

(Optimistic value*its probability) + (pessimistic value*its probability)

optimistic value=$139000 and its probability is 68%=0.68

Pessimistic value=$121000 and its probability is 1-0.68=0.32

Expected value = ($139000*0.68) + ($121000*0.32)

=$133240

However, the value to shareholders is the expected value of the firm less debt of $63000

Equity value=$133240-$63000

=$70240