13. Equity as an option Tiny Pigeon Biotech is a manufacturing firm. Tiny Pigeons current value of operations, including debt and equity, is estimated to be $35 million. Tiny Pigeon has $14 million face-value zero coupon debt that is due in two years. The risk-free rate is 5%, and the volatility of companies similar to Tiny Pigeon is 60%. Tiny Pigeons performance has not been very good as compared to previous years. Because the company has debt, it will repay its loan, but the company has the option of not paying equity holders. The ability to make the decision of whether to pay or not looks very much like an option.

Based on your understanding of the Black-Scholes option pricing model (OPM), calculate the following values and complete the table. (Note: Use 2.7183 as the approximate value of e in your calculations. Do not round intermediate calculations. Round final answers to two decimal places.)

Values: Tiny Pigeon Biotech

Equity value: ____

Debt value: _____

Debt yield: ____

Tiny Pigeons management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce the companys volatility to 30%. (Note: Do not round intermediate calculations. Round final answers to two decimal places.)

Goals: Tiny Pigeon Biotech

Equity value at 30% volatility: ___

Debt value at 30% volatility: ___

Debt yield at 30% volatility: ___

Complete the following sentence, assuming that Tiny Pigeons risk management strategy is successful.

If its risk management strategy is successful and Tiny Pigeon can reduce its volatility, the value of Tiny Pigeons debt will ____, and the value of its stock will _____.