Equity as an option: calculate value of equity and value of debt
Not what you're looking for?
A corporation's assets are currently worth $1,030. In one year, they will be worth either $1,000 or $1,300. The risk-free interest rate is 4%. Suppose they have an outstanding debt issue with a face value of $1,000. This debt is due in one year.
a. The value of the equity is $____?. (Rounded to 2 decimal places.)
b. The value of the debt is $____?. (Round to 2 decimal places) and the interest rate on the debt is____%(Input answer as a whole percent).
c. The value of the equity would either go up or go down____? if the risk-free rate were 7 percent.
Why?
----------------------------
the same problem with these numbers:
assets currently worth $1,040
in one year will be either 1,000 or 1,340
risk free interest rate is 3%
supposethey have an outstanding debt issue with a face value of $1,000. The debt is due in one year.
a,b are the same and for c the risk free rate is 8%
Purchase this Solution
Solution Summary
The solution is very understandable when using call option strategy as a framework. All the formulas and calculations are included to reach the answers.
Solution Preview
When viewing equity as a call option, the value of the "underlying asset" becomes the value of the assets of the firm, and the "strike price" of the option becomes the face-value of the debt. In order to see this, let's start with the value of an option. Let's call S to the price of the underlying asset and K to the strike price. The value of a call option at the time of exercise is:
S - K if S > K -- i.e., if you should exercise it
0 if S <= K -- i.e., if you should choose not to exercise it.
Now let's think of S as the value of the assets and K to the face-value of debt. The value of equity in one year will be:
S - K if S>K ...
Purchase this Solution
Free BrainMass Quizzes
Operations Management
This quiz tests a student's knowledge about Operations Management
Balance Sheet
The Fundamental Classified Balance Sheet. What to know to make it easy.
Introduction to Finance
This quiz test introductory finance topics.
Lean your Process
This quiz will help you understand the basic concepts of Lean.
Basics of corporate finance
These questions will test you on your knowledge of finance.