Question
Company NothingOrAll (NOA) is known to be undertaking a new project. If the project is successful the value of the firm's debt and equity in
Company NothingOrAll (NOA) is known to be undertaking a new project. If the project is successful the value of the firm's debt and equity in a year will be $44 million, if it is unsuccessful the firm's value will be $36 million. NOA has a zero bond issue outstanding, which is due in one year with face value $40 million. The risk-free interest rate is 0.05. NOA's current value of debt and equity is $40 million. NOA pays no dividends.
Make use of the binomial option pricing model to value the equity of NOA as a call option. What is NOA's value of debt (in million $)? What is the value of risk-free debt ( in million$), i.e., since the debt of the company is risky by how much is its value lower compared to risk-free debt?
Assume that NOA finally decides to undertake an even more risky project.NOA has a zero bond issue outstanding with face value 40$mill which is due in one year. The risk-free interest rate is 5%. NOA's current value of debt and equity surprisingly remains at 40$million after the announcement.The risky project implies volatility of 0.2 What is the value of equity as a call option computed with Black Scholes model?
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