Question

Handler Corp. has a zero coupon bond that matures in five years with a face value of $91,000. The current value of the company’s assets is $87,000 and the standard deviation of its return on assets is 38 percent per year. The risk-free rate is 6 percent per year, compounded continuously.

  

a.	What is the value of a risk-free bond with the same face value and maturity as the current bond? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	What is the value of a put option on the company’s assets with a strike price equal to the face value of the debt? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c-1.	Using the answers from (a) and (b), what is the value of the company’s debt? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c-2.	Using the answers from (a) and (b), what is the continuously compounded yield on the company’s debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
d-1.	Assume the company can restructure its assets so that the standard deviation of its return on assets increases to 47 percent per year. What is the new value of the debt? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
d-2.	What is the new continuously compounded yield on the debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
e-1.	If the company restructures its assets, how much will bondholders gain or lose? (A loss should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
e-2.	If the company restructures its assets, how how much will stockholders gain or lose? (A loss should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

	a. Value of risk-free bond b. Price of the put option c-1. Value of company's debt c-2. Return on debt % d-1. Value of debt d-2. Return on debt % e-1. Bondholders' gain / loss e-2. Stockholders' gain / loss

Please answer this question. It might be helpful to use excel. Thanks!

note* a is not  68000.49, b is not 18614.98, c1 is not 52255.89, and c2 is not 11.1

Thanks

Answer 1

(a) Zero-Coupon Bond = $ 91000, Value of Firm's Assets = $ 87000, Standard Deviation = 38% and RIsk-Free Rate = 6 %, Tenure = 5 years

Price of Riks-Free Bond = 91000 / e^(0.06 x 5) = $ 67414.46

(b) In this context, the strike price of the put option is equivalent to the face value of the debt, the underlying asset's price is equivalent to the firm's asset value, the option tenure is equivalent to the debt's maturity and risk-free rate is 6 %

Using an online calculator to determine put price we get:

Put Price = $ 16674.8

(c1) Equity Value = Call Price = $ 36260.34

Debt Value = 87000 - 36260.34 = $ 50739.66

(c2)

Let the continously compounded cost of debt be r

Therefore 50739.66 = 91000 / e^(r x 5)

e^(r x 5) = 91000 / 50739.66 = 1.

r x 5 = = 0.584152

r = 0.11683 or 11.683% ~ 11.68 %

NOTE: Please raise separate queries for solutions to the remaining sub-parts, as one query is restricted to the solution of only one complete question with up to four sub-parts.