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 $100 million. Fethe has $25 million face value, zero coupon debt that is due in 5 years. The risk-free rate is 6%, and the standard deviation of returns for companies similar to Fethe is 60%. Fethe's owners view their equity investment as an option, and they would like to know the value of their investment.

1. Using the Black-Scholes option pricing model, how much is Fethe's equity worth? Do not round intermediate calculations. Enter your answer in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answer to two decimal places.
2. $million
3. How much is the debt worth today? What is its yield? Do not round intermediate calculations. Enter your answer for debt 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.
4. Debt worth today: $million
5. Yield on the debt:%
6. 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 40%? 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.
7. New equity worth: $million
8. New yield on the debt:%
9. Can you explain this?
10. The value of the stock goes down and the value of the debt goes up because with lower risk, Fethe has-Select-lessmoreItem 6of a chance of a "home run".