49. Debt Valuation and Time to Maturity

McLemore Industries has a zero-coupon bond issue that matures in two years with a face value of $47,000. The current value of the companys assets is $27,800, and the standard deviation of the ROA is 58 percent per year. Assume the risk-free rate is 5 percent per year, compounded continuously.

From an examination of the value of the assets of McLemore Industries, and the fact that the debt must be repaid in two years, it seems likely that the company will default on its debt. Management has approached bondholders and proposed a plan whereby the company would repay the same face value of debt, but the repayment would not occur for five years.

a) What is the value of the debt under the proposed plan?

b) What is the new continuously compounded yield on the debt?