Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
expand_more
expand_more
format_list_bulleted
Textbook Question
Chapter 21, Problem 9P
Hema Corp. is an all equity firm with a current market value of $1000 million (i.e., $1 billion), and will be worth $900 million or $1400 million in one year. The risk-free interest rate is 5%. Suppose Hema Corp. issues zero-coupon, one-year debt with a face value of $1050 million, and uses the proceeds to pay a special dividend to shareholders. Assuming perfect capital markets, use the binomial model to answer the following:
- a. What are the payoffs of the firm’s debt in one year?
- b. What is the value today of the debt today?
- c. What is the yield on the debt?
- d. Using Modigliani-Miller, what is the value of Hema’s equity before the dividend is paid? What is the value of equity just after the dividend is paid?
- e. Show that the ex-dividend value of Hema’s equity is consistent with the binomial model. What is the ∆ of the equity, when viewed as a call option on the firm’s assets?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solutionStudents have asked these similar questions
Hema Corp. is an all-equity firm with a current market value of $1,230 million (i.e., $1.23 billion), and will be worth $1,107 million or $1,722 million in one year. The risk-free interest rate is 5%. Suppose Hema Corp. issues zero-coupon, one-year debt with a face value of $1,292 million, and uses the proceeds to pay a special dividend to shareholders. Suppose that in the event Hema Corp. defaults, $90 million of its value will be lost to bankruptcy costs. Assume there are no other market imperfections. a. What is the present value of these bankruptcy costs, and what is their delta with respect to the firm's assets? b. In this case, what is the value and yield of Hema's debt? c. In this case, what is the value of Hema's equity before the dividend is paid? What is the value of equity just after the dividend is paid?
MassGlass Corporation is a firm with $90 million in equity and $20 million in debt. The debt has maturity of 8 years. If we view the equity of this firm as a call option, then we can evaluate this option as one whose exercise price is $____million, whose time to expiration is ____ years, and whose underlying asset has a value of $ ____ million.
The market value of Charcoal Corporation's common stock is $20 million, and the market value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the market risk premium is 8 percent. If the Treasury bill rate is 5 percent, what is the company's cost of capital? (Assume no taxes.)
15.0 percent
14.6 percent
13.0 percent
7.0 percent
Chapter 21 Solutions
Corporate Finance
Ch. 21.1 - What is the key assumption of the binomial option...Ch. 21.1 - Why dont we need to know the probabilities of the...Ch. 21.1 - Prob. 3CCCh. 21.2 - What are the inputs of the Black-Scholes option...Ch. 21.2 - What is the implied volatility of a stock?Ch. 21.2 - How does the delta of a call option change as the...Ch. 21.3 - What are risk-neutral probabilities? How can they...Ch. 21.3 - Does the binominal model or Black-Scholes model...Ch. 21.4 - Is the beta of a call greater or smaller than the...Ch. 21.4 - What is the leverage ratio of a call?
Ch. 21.5 - Prob. 1CCCh. 21.5 - The fact that equity is a call option on the firms...Ch. 21 - The current price of Estelle Corporation stock is...Ch. 21 - Using the information in Problem 1, use the...Ch. 21 - Suppose the option in Example 21.11 actually sold...Ch. 21 - Eagletrons current stock price is 10. Suppose that...Ch. 21 - What is the highest possible value for the delta...Ch. 21 - Hema Corp. is an all equity firm with a current...Ch. 21 - Consider the setting of Problem 9. Suppose that in...Ch. 21 - Roslin Robotics stock has a volatility of 30% and...Ch. 21 - Rebecca is interested in purchasing a European...Ch. 21 - Using the data in Table 21.1, compare the price on...Ch. 21 - Consider again the at-the-money call option on...Ch. 21 - Harbin Manufacturing has 10 million shares...Ch. 21 - Using the information on Harbin Manufacturing in...Ch. 21 - Using the information in Problem 1, calculate the...Ch. 21 - Prob. 23PCh. 21 - Prob. 24PCh. 21 - Calculate the beta of the January 2010 9 call...Ch. 21 - Consider the March 2010 5 put option on JetBlue...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Liu Industries is a highly levered firm. Suppose there is a large probability that Liu will default on its debt. The value of Lius operations is 4 million. The firms debt consists of 1-year, zero coupon bonds with a face value of 2 million. Lius volatility, , is 0.60, and the risk-free rate rRF is 6%. Because Lius debt is risky, its equity is like a call option and can be valued with the Black-Scholes Option Pricing Model (OPM). (See Chapter 8 for details of the OPM.) (1) What are the values of Lius stock and debt? What is the yield on the debt? (2) What are the values of Lius stock and debt for volatilities of 0.40 and 0.80? What are yields on the debt? (3) What incentives might the manager of Liu have if she understands the relationship between equity value and volatility? What might debtholders do in response?arrow_forwardHasting Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.4 (given its target capital structure). Vandell has $10.82 million in debt that trades at par and pays an 8% interest rate. Vandell’s free cash flow (FCFJ is $2 million per year and is expected to grow at a constant rate of 5% a year. Vandell pays a 40% combined federal and state tax rate. The risk-free rate of interest is 5%, and the market risk premium is 6%. Hasting’s First step is to estimate the current intrinsic value of Vandell. What are Vandell’s cost of equity and weighted average cost of capital? What is Vandell’s intrinsic value of operations? [Hint: Use the free cash flow corporate valuation model from Chapter 8.) What is the current intrinsic value of Vandell’s stock?arrow_forwardRefi Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm's debt-equity is expected to rise from 35 percent to 50 percent. The firm currently has $2.7 million worth of debt outstanding. The pretax cost of debt is 6.4 percent. The firm expects to have an aftertax earnings of $940,000 per year in perpetuity. The corporate tax rate is 21 percent. a. What is the expected return on the equity before the repurchase agreement? b. What is the return on assets for the firm? (Hint: use the MM Proposition ll with Tax.) c. What is the expected return on the firm's equity after the repurchase announcement? d. What is the weighted-average cost of capital for the company after the repurchase announcement?.arrow_forward
- Rolex, Inc. has equity with a market value of $20 million and debt with a market value of $10million. Assume the firm has no default risk and can borrow at the risk-free interest rate. Therisk-free interest rate is 5 percent per year, and the expected return on the market portfolio is11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost ofcapital for an otherwise identical all-equity firm?arrow_forwardRolex, Inc. has equity with a market value of $20 million and debt with a market value of $10million. Assume the firm has no default risk and can borrow at the risk-free interest rate. Therisk-free interest rate is 5 percent per year, and the expected return on the market portfolio is11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost ofcapital for an otherwise identical all-equity firm? handwrite pleasearrow_forwardRauch Inc.’s current stock price is $2 per share and it has 300 million shares outstanding. The book value of its equity is $200 million and the book value of its debt is $400 million. Assume that the beta of the firm’s debt is 0.5 and the beta of the firm’s equity is 1.5. The risk-free rate is 3% and the expected return on the market is 9%. Assume that there are no taxes or other market imperfections. What is Rauch’s asset beta? What is Rauch’s asset cost of capital? Assume that Rauch Inc. issues an additional $100 million in debt and uses the proceeds to buy back its equity. What is Rauch’s asset beta after recapitalization? What is Rauch’s asset cost of capital after recapitalization? After the recapitalization described in part (b), Rauch’s debt beta is now 0.6. What is Rauch’s equity beta after recapitalization? What is Rauch’s cost of equity after recapitalization? From the standpoint of Rauch Inc. (i.e., the firm as a whole), what is the net present value(NPV) of the…arrow_forward
arrow_back_ios
arrow_forward_ios
Recommended textbooks for you
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY