4 7 Higgs Bassoon Corporation is a custom manufacturer of bassoons and other wind instruments. 5 Its current value of operations, which is also its value of debt plus equity, is estimated to be 6 $200 million. Higgs has $110 million face value, zero coupon debt that is due in 3 years. The risk- free rate is 5%, and the standard deviation of returns for similar companies is 60%. The owners 8 of Higgs Bassoon view their equity investment as an option and would like to know the value of 9 their investment. 10 11 12 a. Using the Black-Scholes Option Pricing Model, how much is the equity worth? 13 14 Black-Scholes Option Pricing Model 15 Total Value of Firm this is the current value of operations 16 Face Value of Debt 17 Risk Free rate 18 Maturity of debt (years) 19 Standard Dev. this is sigma--also known as volatility 20 d1 use the formula from the text 21 d2 use the formula from the text 22 N(d) use the Normsdist function in the function wizard 23 N(dz) 24 Call Price = Equity Value million 25 26 b. How much is the debt worth today? What is its yield? 27 28 Debt value = Total Value - Equity Value = million 29 Debt yield = 61 62 b. Graph the values of debt and equity for volatilities from 0.10 to 0.90 when the face value of the debt is $2 million. 63 Value of Debt Value of Equity 64 Volatility Face Value of Debt Volatility Face Value of Debt 65 0.00 0.00 66 0.1 0.1 67 0.2 0.2 68 0.3 0.3 69 0.4 0.4 70 0.5 0.5 71 0.6 0.6 72 0.7 0.7 73 0.8 0.8 74 0.9 0.9 75 76 77 78 79 80 81 82 83 84 85 86 87 4 7 Higgs Bassoon Corporation is a custom manufacturer of bassoons and other wind instruments. 5 Its current value of operations, which is also its value of debt plus equity, is estimated to be 6 $200 million. Higgs has $110 million face value, zero coupon debt that is due in 3 years. The risk- free rate is 5%, and the standard deviation of returns for similar companies is 60%. The owners 8 of Higgs Bassoon view their equity investment as an option and would like to know the value of 9 their investment. 10 11 12 a. Using the Black-Scholes Option Pricing Model, how much is the equity worth? 13 14 Black-Scholes Option Pricing Model 15 Total Value of Firm this is the current value of operations 16 Face Value of Debt 17 Risk Free rate 18 Maturity of debt (years) 19 Standard Dev. this is sigma--also known as volatility 20 d1 use the formula from the text 21 d2 use the formula from the text 22 N(d) use the Normsdist function in the function wizard 23 N(dz) 24 Call Price = Equity Value million 25 26 b. How much is the debt worth today? What is its yield? 27 28 Debt value = Total Value - Equity Value = million 29 Debt yield = 61 62 b. Graph the values of debt and equity for volatilities from 0.10 to 0.90 when the face value of the debt is $2 million. 63 Value of Debt Value of Equity 64 Volatility Face Value of Debt Volatility Face Value of Debt 65 0.00 0.00 66 0.1 0.1 67 0.2 0.2 68 0.3 0.3 69 0.4 0.4 70 0.5 0.5 71 0.6 0.6 72 0.7 0.7 73 0.8 0.8 74 0.9 0.9 75 76 77 78 79 80 81 82 83 84 85 86 87