Happyface Corporation is about to launch a new product. Depending on the success of the new product, Happyface may have one of five values next year: $200 million, $180 million, $160 million, $100 million, and $80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 20% of the value of Happyface's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.) Now suppose Happyface has zero-coupon debt with a $120 million face value due next year. What is the initial value of Happyface's equity? What is Happyface's total value with leverage?
Happyface Corporation is about to launch a new product. Depending on the success of the new product, Happyface may have one of five values next year: $200 million, $180 million, $160 million, $100 million, and $80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 20% of the value of Happyface's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.) Now suppose Happyface has zero-coupon debt with a $120 million face value due next year. What is the initial value of Happyface's equity? What is Happyface's total value with leverage?
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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Transcribed Image Text:Happyface Corporation is about to launch a new
product. Depending on the success of the new
product, Happyface may have one of five values
next year: $200 million, $180 million, $160 million,
$100 million, and $80 million. These outcomes are
all equally likely, and this risk is diversifiable.
Suppose the risk-free interest rate is 5% and that, in
the event of default, 20% of the value of
Happyface's assets will be lost to bankruptcy costs.
(Ignore all other market imperfections, such as
taxes.)
Now suppose Happyface has zero-coupon debt with
a $120 million face value due next year. What is the
initial value of Happyface's equity? What is
Happyface's total value with leverage?
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