8. Equity as an option Strong Co. Is a manufacturing firm. Strong Co.'s current value of operations, Including debt and equity, Is estimated to be $5 millon. Strong Co. has $2 million face-value zero coupon debt that is due in two years. The risk-free rate is 6%, and the volatility of companies similar to Strong Co. is 50%. Strong 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. Besed on your understanding of the Black-Scholes option pricing model (OPM), calkulate 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.) Strong Co. Value (Millions of dollars) Equity value Debt value Debt yield Strong Co.'s management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce Strong Co.s volatility to 30%. Strong Co. Goal (Millions of dollars) Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility
8. Equity as an option Strong Co. Is a manufacturing firm. Strong Co.'s current value of operations, Including debt and equity, Is estimated to be $5 millon. Strong Co. has $2 million face-value zero coupon debt that is due in two years. The risk-free rate is 6%, and the volatility of companies similar to Strong Co. is 50%. Strong 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. Besed on your understanding of the Black-Scholes option pricing model (OPM), calkulate 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.) Strong Co. Value (Millions of dollars) Equity value Debt value Debt yield Strong Co.'s management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce Strong Co.s volatility to 30%. Strong Co. Goal (Millions of dollars) Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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Transcribed Image Text:8. Equity as an option
Strong Co. Is a manufacturing firm. Strong Co.'s current value of operations, Including debt and equity, is estimated to be $5 million. Strong Co. has
$2 million face-value zero coupon debt that is due in two years. The risk-free rate is 6%, and the volatility of companies similar to Strong Co. is 50%.
Strong 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 intermedlate calculations. Round your answers to two decimal places.)
Strong Co. Value (Millions of dollars)
Equity value
Debt value
Debt yield
Strong Co.'s management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is
to reduce Strong Co.'s volatility to 30%.
Strong Co. Goal (Millions of dollars)
Equity value at 30% volatility
Debt value at 30% volatility
Debt yield at 30% volatility
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