Question

What would B and C excel functions be?

Higgs Bassoon Corporation is a custom manufacturer of bassoons and other wind instruments. Its current value of operations, which is also its value of debt plus equity, is estimated to be $200 million. Higgs has $110 million face value, zero coupon debt that is due in 3 years. The risk-free rate is 5%, and the standard deviation of returns for similar companies is 60%. The owners of Higgs Bassoon view their equity investment as an option and would like to know the value of their investment.

a. Using the Black-Scholes Option Pricing Model, how much is the equity worth?

Black-Scholes Option Pricing Model

Total Value of Firm

200.00

this is the current value of operations

Face Value of Debt

110.00

Risk Free rate

5%

Maturity of debt (years)

3.00

Standard Dev.

60%

this is sigma--also known as volatility

d1

1.2392

use the formula from the text

d2

0.2000

use the formula from the text

N(d1)

0.8924

use the Normsdist function in the function wizard

N(d2)

0.5793

Call Price = Equity Value

$       123.63

million

b. How much is the debt worth today? What is its yield?

Debt value = Total Value - Equity Value =

million

Debt yield =

c. How much would the equity value and the yield on the debt change if Fethe's management were able to use risk management techniques to reduce its volatility to 45 percent? Can you explain this?

Equity value at 60% volatility

million

Equity value at 45% volatility

million

Percent change

million

Answer 1

b. How much is the debt worth today? What is its yield?
Firm Value	200
Debt value = Total Value - Equity Value =				$76.37	million
Debt yield =				12.93%	Used the Formula = [(Face Value/ Current Value)^(1/t)] -1
					Alternatively you can use the yield function in excel too
					YIELD (sd, md, rate, pr, redemption, frequency, [basis])

c)

c. How much would the equity value and the yield on the debt change if Fethe's management were able to use risk management techniques to reduce its volatility to 45 percent? Can you explain this?
							Equity value at 45% volatility			$112.16	million
							Equity value at 60% volatility			$123.63	million
Percent change			9.27%
Risk Free rate		5%
Maturity of debt (years)		3
Standard Dev.		45%	60%
d1		0.9595	1.2392
d2		0.1801	0.2000
N(d1)		0.8313	0.8924
N(d2)		0.5714	0.5793
Call Price = Equity Value (in millions)		$112.16	$123.63