A B C D E F G H | 11 5678901234567800 21 22 23 24 25 26 27 28 Higgs Bassoon Corporation is a custom manufacturer of bassoons and other wind instruments. Its current value of operations, which is also its value of debt plus equity, is estimated to be $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 of Higgs Bassoon view their equity investment as an option and would like to know the value of their investment. a. Using the Black-Scholes Option Pricing Model, how much is the equity worth? Black-Scholes Option Pricing Model Total Value of Firm Face Value of Debt Risk Free rate Maturity of debt (years) Standard Dev. d d2 N(d) N(d2) Call Price = Equity Value 200.00 this is the current value of operations 100.00 5% 3.00 0.45 this is sigma--also known as volatility 1.4715 use the formula from the text 0.6920 use the formula from the text 0.9294 use the Normsdist function in the function wizard 0.7555 $ 120.85 million b. How much is the debt worth today? What is its yield? Debt value = Total Value - Equity Value = 29 Debt yield= 30 31 32 33 34 $ 79.15 million 8.107 % c. How much would the equity value and the yield on the debt change if Fethe's management were able to use risk management techniques to reduce its volatility to 45 percent? Can you explain this? 35 Equity value at 60% volatility 36 Equity value at 45% volatility 122222233333333334444444444555555555 234567800-234567800-234567800234567 58 128.76748 million 120.85314 million -6.1% million 37 Percent change 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 d. Graph the cost of debt versus the face value of debt for values of the face value from $0.5 to $8 million. Cost of Debt Face Value of Debt 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 hint: use a data table 160