Question
Gladstone Corporation is about to launch a new product. Depending on the success of the newproduct, Gladstone may have one of four values nextyear:$147million,$138million,$95million, and
Gladstone Corporation is about to launch a new product. Depending on the success of the newproduct, Gladstone may have one of four values nextyear:$147million,$138million,$95million, and $83million. These outcomes are all equallylikely, and this risk is diversifiable. Gladstone will not make any payouts to investors during the year. Suppose therisk-free interest rate is 5.3%and assume perfect capital markets.
a. What is the initial value ofGladstone's equity withoutleverage?
Now suppose Gladstone haszero-coupon debt with a $100million face value due next year.
b. What is the initial value ofGladstone's debt?
c. What is theyield-to-maturity of thedebt? What is its expectedreturn?
d. What is the initial value ofGladstone's equity? What isGladstone's total value withleverage?
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