Page 4 Question 5 [15 marks] The cash flows of company X at the end of the year depend on the state of the economy. which can be good or bad. Each state is equally likely. In the good state the company is worth $120 million and in the bad state it is worth $20 million. We assume that no further cash-flows are expected after that. The firm needs to raise $40 million of debt today in order to repay its previous debt. Everyone is risk neutral and the discount rate is zero. a) Find the face value of debt and the value of equity of company X [8 marks] b) Now assume that if company X defaults it would incur a bankruptcy cost of 5. How would your answer to question 5a) change? Discuss your findings. [7 marks)