Good Time Co. is a regional chain department store. It will remain in business for one more

year. The estimated probability of a boom next year is 0.60 and the estimated probability of a

recession is 0.40. It is projected that Good Time will have a total cash flow of $250 million in

a boom year and $100 million in a recession. Good Times required debt repayment next year

is $150 million. The firm has few fixed assets, so assume that after next year is over the firm

will be liquidated for $0. Assume also that investors are risk-neutral and that interest rates are

zero (i.e., no discounting is necessary). There are no taxes.

a) Assuming that there were no financial distress costs or bankruptcy costs, calculate the

market value of Good Times (i) equity and (ii) debt.

b) If the market value of equity is actually $60 million and the market value of debt is

actually $125 million, what is the markets estimate of financial distress/bankruptcy

costs?