Doubts

Point d of Topic 8 (Limits to the Use of Debt)

Point d of Topic 8 (Limits to the Use of Debt)

by Chiara Santangelo -
Number of replies: 3

Dear Professor,

I hope you're doing well. I have a question regarding Exercise 3, point d of the slides in class for Topic 8 (Limits to the Use of Debt).

In the middle scenario, I noticed that you kept in the 2/3 and also included the 20 that is part of the third scenario. However, in the worst-case scenario, you only consider the 20 without multiplying it by 2/3. Could you please explain the reasoning behind this difference? Why is the 2/3 factor applied in the middle scenario, but not in the worst-case scenario?

Thank you for your help, and I look forward to your clarification.


In reply to Chiara Santangelo

Re: Point d of Topic 8 (Limits to the Use of Debt)

by Julio Crego -
Dear Chiara,

I am sorry, but I cannot find the 20 and 2/3 you refer to (there are many unfortunately). Can you include a snapshot?

Best
In reply to Julio Crego

Re: Point d of Topic 8 (Limits to the Use of Debt)

by Chiara Santangelo -


In reply to Chiara Santangelo

Re: Point d of Topic 8 (Limits to the Use of Debt)

by Julio Crego -
When we check whether the medium scenario is bankrupt, we use the maximum amount without going bankrupt. In this case, we have 2/3 probability of no bankruptcy; hence, the debt payment is paid with probability 2/3 and the financial distress costs with 1/3 probability. Once we look for bankruptcy in the worst scenario, there is no bankruptcy.