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 = 31 c. How much would the equity value and the yield on the debt change if Fethe's management 32 were able to use risk management techniques to reduce its volatility to 45 percent? Can you 33 explain this? 34 35 Equity value at 60% volatility million 36 Equity value at 45% volatility million 37 Percent change million 38 39 40 d. Graph the cost of debt versus the face value of debt for values of the face value from $0.5 to $8 million. 41 Cost of Debt 42 Face Value of Debt hint: use a data table 43 10 44 20 45 30 46 40 47 50 48 60 49 70 50 80 51 90 52 100 53 110 54 120 55 130 56 140 57 150 58 160 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 = 31 c. How much would the equity value and the yield on the debt change if Fethe's management 32 were able to use risk management techniques to reduce its volatility to 45 percent? Can you 33 explain this? 34 35 Equity value at 60% volatility million 36 Equity value at 45% volatility million 37 Percent change million 38 39 40 d. Graph the cost of debt versus the face value of debt for values of the face value from $0.5 to $8 million. 41 Cost of Debt 42 Face Value of Debt hint: use a data table 43 10 44 20 45 30 46 40 47 50 48 60 49 70 50 80 51 90 52 100 53 110 54 120 55 130 56 140 57 150 58 160