Fundamentals of Corporate Finance
11th Edition
ISBN: 9780077861704
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 24, Problem 7QP
Equity as an Option [LO4] Rackin Pinion Corporation’s assets are currently worth $1,025. In one year, they will be worth either $1,000 or $1,290. The risk-free interest rate is 4.5 percent. Suppose the company has an outstanding debt issue with a face value of $1,000.
a. What is the value of the equity?
b. What is the value of the debt? The interest rate on the debt?
c. Would the value of the equity go up or down if the risk-free rate were 20 percent? Why? What does your answer illustrate?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
7. Calculating Cost of Debt For the firm in Problem 6, suppose the book
value of the debt issue is $135 million. In addition, the company has a
second debt issue, a zero coupon bond with 12 years left to maturity; the
book value of this issue is $65 million, and it sells for 64.3 percent of par.
LO 2
What is the total book value of debt? The total market value? What is the
aftertax cost of debt now?
The current value of a firm is $1,400. Te firm has $1,000 in pure debt due in one year and the risk-free rate is 6%. The firm's asset will be worth either $1,200 or $1,500 in one year. What is the interest rate on the debt?
A. 6.0%
B. 7.0%
C. 7.5%
D. 11.0%
E. 13.0%
:38
Solve the following problems regarding bank loans, bonds, and stocks. Assume an interest rate of 10 percent.
a. How much would you pay for a 10-year bond with a par value of $1,000 and a 8.3 percent coupon rate? Assume interest is paid
annually.
b. How much would you pay for a share of preferred stock paying a $5.7-per-share annual dividend forever?
c. A company is planning to set aside money to repay $163 million in bonds that will be coming due in ten years. How much money
would the company need to set aside at the end of each year for the next ten years to repay the bonds when they come due? How
would your answer change if the money were deposited at the beginning of each year?
Note: Round your answers to 2 decimal places.
a. PV
b. PV
c1. PMT
million
tes
c2. PMT
9.30 million
Chapter 24 Solutions
Fundamentals of Corporate Finance
Ch. 24.1 - What is a call option? A put option?Ch. 24.1 - If you thought that a stock was going to drop...Ch. 24.2 - What is the value of a call option at expiration?Ch. 24.2 - What are the upper and lower bounds on the value...Ch. 24.2 - Prob. 24.2CCQCh. 24.3 - Prob. 24.3ACQCh. 24.3 - Prob. 24.3BCQCh. 24.3 - Prob. 24.3CCQCh. 24.4 - Prob. 24.4ACQCh. 24.4 - Prob. 24.4BCQ
Ch. 24.5 - Why do we say that the equity in a leveraged firm...Ch. 24.5 - All other things being the same, would the...Ch. 24.6 - Prob. 24.6ACQCh. 24.6 - Prob. 24.6BCQCh. 24.6 - Prob. 24.6CCQCh. 24.7 - Prob. 24.7ACQCh. 24.7 - Prob. 24.7BCQCh. 24.7 - Prob. 24.7CCQCh. 24.7 - Prob. 24.7DCQCh. 24 - Steve sold a put option when the option premium...Ch. 24 - Prob. 24.2CTFCh. 24 - Prob. 24.4CTFCh. 24 - Prob. 1CRCTCh. 24 - Prob. 2CRCTCh. 24 - Prob. 3CRCTCh. 24 - Prob. 4CRCTCh. 24 - Prob. 5CRCTCh. 24 - Options and Stock Risk [LO2] If the risk of a...Ch. 24 - Prob. 7CRCTCh. 24 - Prob. 8CRCTCh. 24 - Prob. 9CRCTCh. 24 - Prob. 10CRCTCh. 24 - Prob. 11CRCTCh. 24 - Prob. 12CRCTCh. 24 - Prob. 13CRCTCh. 24 - Prob. 14CRCTCh. 24 - Prob. 15CRCTCh. 24 - Calculating Option Values [LO2] T-bills currently...Ch. 24 - Understanding Option Quotes [LO1] Use the option...Ch. 24 - Calculating Payoffs [LO1] Use the option quote...Ch. 24 - Calculating Option Values [LO2] The price of Build...Ch. 24 - Calculating Option Values [LO2] The price of...Ch. 24 - Using the Pricing Equation [LO2] A one-year call...Ch. 24 - Equity as an Option [LO4] Rackin Pinion...Ch. 24 - Equity as an Option [LO4] Buckeye Industries has...Ch. 24 - Calculating Conversion Value [LO6] A 1,000 par...Ch. 24 - Convertible Bonds [LO6] The following facts apply...Ch. 24 - Calculating Values for Convertibles [LO6] You have...Ch. 24 - Calculating Warrant Values [LO6] A bond with 20...Ch. 24 - Prob. 13QPCh. 24 - Prob. 14QPCh. 24 - Prob. 15QPCh. 24 - Prob. 16QPCh. 24 - Intuition and Option Value [LO2] Suppose a share...Ch. 24 - Intuition and Convertibles [LO6] Which of the...Ch. 24 - Convertible Calculations [LO6] Starset, Inc., has...Ch. 24 - Abandonment Decisions [LO5] Allied Products, Inc.,...Ch. 24 - Pricing Convertibles [LO6] You have been hired to...Ch. 24 - Abandonment Decisions [LO5] Consider the following...Ch. 24 - SS Airs Convertible Bond SS Air is preparing its...Ch. 24 - Prob. 2MCh. 24 - Prob. 3MCh. 24 - Prob. 4MCh. 24 - Prob. 5M
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Wolfrum Technology (WT) has no debt. Its assets will be worth $467 million one year from now if the economy is strong, but only $295 million in one year if the economy is weak. Both events are equally likely. The market value today of its assets is $291 million. a. What is the expected return of WT stock without leverage? b. Suppose the risk-free interest rate is 5%. If WT borrows $139 million today at this rate and uses the proceeds to pay an immediate cash dividend, what will be the market value of its equity just after the dividend is paid, according to MM? c. What is the expected return of WT stock after the dividend is paid in part (b)? a. The unievered expected return of WT stock is (Round to two decimal places)arrow_forwardConsider a two-date binomial model. A company has both debt and equity in its capital structure. The value of the company is 100 at Date 0. At Date 1, it is equally like that the value of the company increases by 20% or decreases by 10%. The total promised amount to the debtholders is 100 at Date 1. The riskfree interest rate is 10%. a. What is the value of the debt at Date 0? What is the value of the equity at Date 0? b. Suppose the government announces that it guarantees the company’s payment to the debtholders. How much is the government guarantee worth?arrow_forwardD3) Finance Suppose that there is 30-year coupon bond with par value of $100 and Macaulay duration of 20.56. The coupon rate is unknown. Currently, the bond is traded at $90 and the yield is flat at 20% pa. Yield to maturity is an annualized simple interest rate compounded annually. If the bond yield increases by 50 basis points, what is the approximation of the percentage capital gain or loss? Please choose the correct range for the percentage capital gain/loss, i.e., if it is -3.5%, please select “A value between -3% and -4%” A value between -9% and -10% A value between -8% and -9% None of the other answers are correct. A value between -7% and -8% A value between -10% and -11%arrow_forward
- which one is correct please confirm? QUESTION 5 Heleveton Industries is 100% equity financed. Its current beta is 1.1. The expected market risk premium is 8.5%, and the risk-free rate is 4.2%. If Heleveton changes its capital structure to 25% debt, it estimates its beta will increase to 1.2. If the after-tax cost of debt will be 6%, should Heleveton make the capital structure change? a. Yes, cost of capital decreases 1.67% b. No, cost of capital increases by 0.85% c. Yes, cost of capital decreases by 2.52% d. No, stock price would decrease due to increased riskarrow_forwardConsider a simple firm that has the following market-value balance sheet: Assets Liabilities end equity $1 040 Debt Equity $400 640 Next year, there are two possible values for its assets, each equally likely: $1 180 and $960. Its debt will be due with 4.9% interest. Because all of the cash flows from the assets must go to either the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 38% in the firm's debt and 62% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's pre-tax WACC is the same as the expected return on its assets. If the assets will be worth $1 180 in one year, the expected return on assets will be %. (Round to one decimal place.)arrow_forwardA3) Finance Suppose that the risk-free interest rate is 10% per annum with continuous compounding and that the dividend yield on a stock index is 4% per annum. The index is standing at 400, and the futures price for a contract deliverable in four months is 405. What arbitrage opportunities does this create?arrow_forward
- 6. Problem 12-12 Capital Structure Analysis Hagen Horticulture and Supplies Limited has no debt outstanding, and its financial position is given by the following data: Assets (book market) EBIT Cost of equity, r Stock price, P Shares outstanding, n, Tax rate, T The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 40% debt based on market values, its cost of equity, f,, will increase to 9.57% to reflect the increased risk. Bonds can be sold at a cost, ra, of 7%. Hagen is a no-growth. firm. Hence, all its earnings are paid out as dividends, and earnings are expected to be constant over time. a. What effect would this use of leverage have on the value of the firm? The value of the firm would I $4,000,000 $500,000 8.75% $8 500,000 30% b. What would be the market value of Hagen's equity? Market value of equity=$arrow_forwardQ.A company will earn net profits of $100,000 if the economy booms (probability of 80%) and net profits of $60,000 if the economy enters a recession (probability of 20%). The company wants to take out a loan for $74,000 to finance its operations.Treasuries of the same maturity offer an interest rate of 6%. Assume risk neutrality. A)What payoff would the bank receive if it invested $74,000 in Treasuries? B)What payout should the bank be looking for during the boom (in $)? C)What interest rate should the bank quote?arrow_forward4. Suppose a firm with a value of $60 million has a bond outstanding with a face value of $50 million that matures in 2 years. the current interest rate is 6% and the volatility of the firm is 25% what is the probability that the firm will default on its debt if the expected return on the firm, µ, is 30% ?what is the expected loss given default?arrow_forward
- A company needs ghc1000 to finance its activities. The firm can finance this expenditure either by bonds or equity. Interest rate on bonds is 10%. The company can earn ghe 160 in good years and ghc80 in bad years. Assuming the firm faces one-quarter probability of good years; What will be the stream of returns on both bonds and equity if the company chooses the following financing options? i. a. 100% equity financing ii. 50% equity financing iii. 20% equity financing iv. 0% equity financing Estimate the equity risk associated with each option in (a) As an investor who wants to purchase a share in the company, which financing option will make you purchase the stock. Why? b. C.arrow_forward3 Next period a firm will be worth $56 with 10% probability, $98 with 55% probability, and $152 otherwise. The firm has one senior bond outstanding with a face value of $33 and one junior bond outstanding with a face value of $30. The senior bond has a promised return of 4%. The junior bond has a promised return of 13%. The firm's required return on assets is 12%. What is the value of the firm?arrow_forwardConsider a two-date binomial model. A company has both debt and equity in its capital structure. The value of the company is 100 at Date 0. At Date 1, it is equally like that the value of the company increases by 20% or decreases by 10%. The total promised amount to the debtholders is 100 at Date 1. The riskfree interest rate is 10%. a. What are the possible payoffs to the equityholders at date 1? What kind of financial product has the same payoffs? Please describe the detailed characteristics of the financial product. b. What are the possible payoffs to the bondholders at date 1? Are they riskfree? What kind of financial product/portfolio has the same payoffs? Please describe the detailed characteristics of the financial product/portfolio.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education
Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY