Question

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?

Answer 1

The value of this firm to shareholders is $70240

Step-by-step 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