28 Equity as an Option and NPV A company has a single zero coupon bond outstanding that matures in 10 years with a face value of £30 million. The current value of the company’s assets is £22 million, and the standard deviation of the return on the firm’s assets is 39 per cent per year. The risk-free rate is 6 per cent per year, compounded continuously.

(a) What is the current market value of the company’s equity?

(b) What is the current market value of the company’s debt?

(c) What is the company’s continuously compounded cost of debt?

(d) The company has a new project available. The project has an NPV of £750,000. If the company undertakes the project, what will be the new market value of equity? Assume volatility is unchanged.

(e) Assuming the company undertakes the new project and does not borrow any additional funds, what is the new continuously compounded cost of debt? What is happening here?