14. Equity as an option Consider the case of Blue Gecko Pharmaceuticals: Blue Gecko Pharmaceuticals is a manufacturing firm. Blue Gecko's current value of operations, including debt and equity, is estimated to be $35 million. Blue Gecko 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 Blue Gecko is 60%. Blue Gecko's 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: Blue Gecko Pharmaceuticals Equity value Debt value Debt yield Blue Gecko's management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce the company's volatility to 30%. (Note: Do not round intermediate calculations. Round final answers to two decimal places.) Goals: Blue Gecko Pharmaceuticals Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility Complete the following sentence, assuming that Blue Gecko's risk management strategy is successful: and the If its risk management strategy is successful and Blue Gecko can reduce its volatility, the value of Blue Gecko's debt will value of its stock will 14. Equity as an option Consider the case of Blue Gecko Pharmaceuticals: Blue Gecko Pharmaceuticals is a manufacturing firm. Blue Gecko's current value of operations, including debt and equity, is estimated to be $35 million. Blue Gecko 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 Blue Gecko is 60%. Blue Gecko's 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: Blue Gecko Pharmaceuticals Equity value Debt value Debt yield Blue Gecko's management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce the company's volatility to 30%. (Note: Do not round intermediate calculations. Round final answers to two decimal places.) Goals: Blue Gecko Pharmaceuticals Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility Complete the following sentence, assuming that Blue Gecko's risk management strategy is successful: and the If its risk management strategy is successful and Blue Gecko can reduce its volatility, the value of Blue Gecko's debt will value of its stock will
