Example: Value of the firm: either 100 (good state) or 40 (bad state) with equal

chance. Face value of debt: 60. Find expected payoff to shareholders, bondhol-

ders, and expected value of the firm.

Shareholders:

0.5 100 60 + 0.5 0 = 20

Bondholders:

0.5 60 + 0.5 40 = 50

Firm value:

0.5 100 + 0.5 40 = 70

Example (contd): New investment opportunity, pays 70 in good state and 60

in bad state. Requires 60 upfront and is financed with junior debt (subordina-

ted to senior debt), i.e. junior debtholders claim after senior debtholders.

Question: how to calculate the payoffs of junior holder? The answer I have posted. I need the method.

Payoffs wl risky project Good state Bad state Exp. value wlo risk project i1o bo Total Debt Junior debt 8 1 o Equity 12s Go bo 2 30