A company has its debt structured as a single zero-coupon bond that matures in 5 years. The face value of the debt outstanding is $40 million and the current value of the company's total assets is $36 million. The standard deviation of the return of its assets is 30 percent per year, and the risk-free rate is estimated to be about 5 percent per year, compounded continuously. Compute the following quantities: 1. Current market value of the company's equity 2. Current market value of the company's debt 3. Continuously compounded cost of debt
A company has its debt structured as a single zero-coupon bond that matures in 5 years. The face value of the debt outstanding is $40 million and the current value of the company's total assets is $36 million. The standard deviation of the return of its assets is 30 percent per year, and the risk-free rate is estimated to be about 5 percent per year, compounded continuously. Compute the following quantities: 1. Current market value of the company's equity 2. Current market value of the company's debt 3. Continuously compounded cost of debt
Chapter6: Fixed-income Securities: Characteristics And Valuation
Section: Chapter Questions
Problem 15P
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Debenture Valuation
A debenture is a private and long-term debt instrument issued by financial, non-financial institutions, governments, or corporations. A debenture is classified as a type of bond, where the instrument carries a fixed rate of interest, commonly known as the ‘coupon rate.’ Debentures are documented in an indenture, clearly specifying the type of debenture, the rate and method of interest computation, and maturity date.
Note Valuation
It is the process to determine the value or worth of an asset, liability, debt of the company. It can be determined by many processes or techniques. Many factors can impact the valuation of an asset, liability, or the company, like:
Question
Transcribed Image Text:A company has its debt structured as a single zero-coupon bond that matures in 5
years. The face value of the debt outstanding is $40 million and the current value of the
company's total assets is $36 million. The standard deviation of the return of its assets is
30 percent per year, and the risk-free rate is estimated to be about 5 percent per year,
compounded continuously.
Compute the following quantities:
1. Current market value of the company's equity
2. Current market value of the company's debt
3. Continuously compounded cost of debt
Suppose this company has a new project opportunity available. This project has an
estimated NPV of $3,000,000.
4. If the company undertakes the project, what will be the new market value of
equity? Assume volatility is unchanged.
5. Assuming the company decided to undertake the new project and does not borrow
any additional funds, what is the new continuously compounded cost of debt?
Explain in detail the impact this project has on the cost of debt.
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