Intermediate Financial Management (MindTap Course List)
12th Edition
ISBN: 9781285850030
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 16, Problem 12P
a)
Summary Introduction
To determine: Company F’s equity worth by using Black-Scholes option model.
b)
Summary Introduction
To determine: Current worth of debt and yield.
c)
Summary Introduction
To discuss: Impact of equity value and yield on debt change on reducing the volatility to 30%.
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Equity Viewed as an Option
A. Fethe Inc. is a custom manufacturer of guitars, mandolins,and other stringed instruments and is located near Knoxville,Tennessee. Fethe's current value of operations, which is also its value of debt plus equity, is estimated to be $5 million. Fethe has $2 million face value, zero coupon debt that is due in 2 years. The risk-free rate is 6%, and the standard deviation of returns for companies similar to Fethe is 50%. Fethe's owners view their equity investment as an option and they would like to know the value oftheir investment.
a. Using the Black-Scholes option pricing model, how much isFethe's equity worth? In your calculations round normaldistribution values to 4 decimal places. Round your answer to twodecimal places.
$__________ million ?
b.How much is the debt worth today? What is its yield? Roundyour answer for the debt worth to two decimal places. Round youranswer for the yield on the debt to one decimal place.
Debt worth today: $…
Equity as an option Carlson Co. is a manufacturing firm. Carlson Co.’s current value of operations, including debt and equity, is estimated to be $15 million. Carlson Co. has $6 million face-value zero coupon debt that is due in five years. The risk-free rate is 5%, and the volatility of companies similar to Carlson Co. is 50%. Carlson Co.’s performance has not been very good as compared to previous years. Because the company has debt, it will repay its loan, but the company has the option of not paying equity holders. The ability to make the decision of whether to pay or not looks very much like an option. Based on your understanding of the Black-Scholes option pricing model (OPM), calculate the following values and complete the table. (Note: Use 2.7183 as the approximate value of e in your calculations. Also, do not round intermediate calculations. Round your answers to two decimal places.)
Carlson Co. Value (Millions of dollars)
Equity value_______
Debt value _______
Debt…
Equity as an OptionSunburn Sunscreen has a zero coupon bond issue outstanding with a $20,000 face value that matures in one year. The current market value of the firm’s assets is $21,700. The standard deviation of the return on the firm’s assets is 38 percent per year, and the annual risk-free rate is 5 per cent per year, compounded continuously. Based on the Black–Scholes model, what is the market value of the firm’s equity and debt?
Q.How do find the value of N(1) and N(2) from the table? Please explain clearly. In the answer, how did they get the value from the table? Shouldn't the value be N(1) = 0.7054 and N(2) = 0.5596? I am very confused.
In the answer the values are -
N(d1) = .7041N(d2) = .5621
The answer to this question is attached.
Chapter 16 Solutions
Intermediate Financial Management (MindTap Course List)
Ch. 16 - Prob. 1QCh. 16 - Prob. 2QCh. 16 - Prob. 3QCh. 16 - One type of leverage affects both EBIT and EPS....Ch. 16 - Prob. 5QCh. 16 - Prob. 6QCh. 16 - Prob. 7QCh. 16 - Prob. 8QCh. 16 - Prob. 9QCh. 16 - Prob. 1P
Ch. 16 - Unlevered Beta
Counts Accounting’s beta is 1.15...Ch. 16 - Premium for Financial Risk
Ethier Enterprise has...Ch. 16 - Value of Equity after Recapitalization Nichols...Ch. 16 - Stock Price after Recapitalization Lee...Ch. 16 - Prob. 6PCh. 16 - Prob. 7PCh. 16 - Capital Structure Analysis Pettit Printing Company...Ch. 16 - Optimal Capital Structure with Hamada
Beckman...Ch. 16 - WACC and Optimal Capital Structure F. Pierce...Ch. 16 - Prob. 12PCh. 16 - Prob. 1MCCh. 16 - Prob. 2MCCh. 16 - Prob. 3MCCh. 16 - Prob. 4MCCh. 16 - Prob. 5MCCh. 16 - Prob. 6MCCh. 16 - What does the empirical evidence say about capital...
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