Question

Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of the company’s assets is currently $1,140. Urban Meyer, the CEO, believes that the assets in the company will be worth either $970 or $1,430 in a year. The going rate on one-year T-bills is 6 percent.

a-1.	What is the value of the company’s equity? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a-2.	What is the value of the debt? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

     

Suppose the company can reconfigure its existing assets in such a way that the value in a year will be $850 or $1,650.

b.	If the current value of the assets is unchanged, what is the new value of the company's equity? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

     

Answer 1

Given;

Firm's asset = $1140

Face value = $1000

T - bill rate = 6%

A)

value of equity (EO)

Current stock price = [($1430-$970)/($1430-$1000)EO] + 970/1.06

$1140 = [($1430-$970)/($1430-$1000)EO] + 970/1.06

Value of equity (EO) = $210.24

Current value of debt (DO). = Value if firm's asset - value of equity

= $1140 - $210.24

= $929.76

.

B)

Value of new equity(EO)

Current stock price = [($1650-$850)/($1650-1000)EO] + $850/1.06

Value of equity = $274.62

.

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