Question
Strudler Real Estate, Inc., a construction firm financed by both debt and equity, is undertaking a new project. If the project is successful, the value
Strudler Real Estate, Inc., a construction firm financed by both debt and equity, is undertaking a new project. If the project is successful, the value of the firm in one year will be $360 million, but if the project is a failure, the firm will be worth only $230 million. The current value of Strudler is $270 million, a figure that includes the prospects for the new project. Strudler has outstanding zero coupon bonds due in one year with a face value of $300 million. Treasury bills that mature in one year yield a 9 percent EAR. Strudler pays no dividends.
a. Use the two-state option pricing model to calculate the current value of Strudler?s debt and equity.
b. Suppose Strudler has 800,000 shares of common stock outstanding. What is the price per share of the firm?s equity?
c. Suppose that in place of the preceding project, Strudler?s management decides to undertake a project that is even more risky. The value of the firm will either increase to $395 million or decrease to $215 million by the end of the year. Surprisingly, management concludes that the value of the firm today will remain at exactly $270 million if this risky project is substituted for the less risky one. Use the two-state option pricing model to determine the values of the firm?s debt and equity if the firm plans on undertaking this new project.
Debt Equity 69 $ $ Price per share 69 $ Value of Debt Value of Equity 69 69
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