Equity Viewed as an Option

A. Fethe Inc. is a custom manufacturer of guitars, mandolins, and other stringed instruments and is located near Knoxville, Tennessee. Fethe's current value of operations, which is also its value of debt plus equity, is estimated to be $80 million. Fethe has $40 million face value, zero coupon debt that is due in 5 years. The risk-free rate is 4%, and the standard deviation of returns for companies similar to Fethe is 40%. Fethe's owners view their equity investment as an option, and they would like to know the value of their investment.

How would the equity value and the yield on the debt change if Fethe's managers could use risk management techniques to reduce its volatility to 20%? Do not round intermediate calculations. Enter your answer for equity worth in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round the monetary value to two decimal places and percentage value to one decimal place.

New equity worth: $ million

New yield on the debt: %

Can you explain this?

The value of the stock goes down and the value of the debt goes up because with lower risk, Fethe has -Select- Less or More of a chance of a "home run".