3. Suppose that you are examining a company as a potential acquisition target. Your

analyst did a DCF analysis, and you know that the company has a total (enterprise)

value of $140 million. Your analyst looked at the numbers over time, and estimated

that the volatility of its assets is 30%. You want to put in an oer to purchase all of

the equity of the company, because that would give you control. The company has

(zero-coupon) risky debt outstanding with a principal amount of $70 million. All of the

debt is due in 1 year, and it all has the same seniority. The current risk-free interest

rate is 3%.

(a) Draw a payo diagram of the company's equity and debt as a function of the

company's asset value in 1 year (i.e. the maturity of the debt). (Draw them on

the same graph)

(b) What is the value of the company's equity, given the amount of debt it has

outstanding? (You may use a Black-Scholes-Merton calculator)

(c) Before you are able to make your oer to purchase the company's equity, the

company announces that it is splitting its debt into two dierent seniorities. It

will now have senior debt with an outstanding principal amount of $30 million,

and junior debt with an outstanding principal amount of $40 million. Draw a

payo diagram of the company's senior debt and junior debt as a function of the

company's asset value in 1 year. (Draw them on the same graph)

(d) You wonder whether the company's decision should aect your oer. What is the

market value of the company's equity after the company splits its debt? Compare

your answer to part (b), and explain.

(e) What is the market value of the company's junior debt?

(f) What is the market value of the company's senior debt?