A company is on the verge of a new product launch. Depending on how well the product does in the marketplace, three possible outcomes for next years valuation are: $210m, $150m or $60m. The risk is diversifiable and the outcomes are equally likely. Assume that the risk free interest rate is 5% and ignore all other market imperfections, such as taxes. The company has $120 million in debt due next year.
1. What is the companies total value with leverage?
2. In the event of default 30% of the value of the companies assets will be lost in bankruptcy. What is the companies total value with leverage and distress costs?