Question
How do I estimate the financial distress (bankruptcy) cost through put option valuation in excel.? Assume that the market value of the company's assets before
How do I estimate the financial distress (bankruptcy) cost through put option valuation in excel.?
Assume that the market value of the company's assets before recapitalisation is $750 million. The variance of the company's share price is estimated as 2.25% (reasonable proxy for the company's assets volatility since there has been no debt usage in the firm). Assume a zero dividend yield. The natural number is '2.718'. Interpret the result.
It was right at the beginning of 2019. Myron Bronco Incorporation (MB) was a medium-sized
company listed in a share market. Largely owned by a traditional and financially conversative
elite family, the company operated in a lower-risk and mildly-competitive industry. With thin
trading of its shares in the stock exchange, the family has been considerably successful in
controlling major decisions/directions made by the company. The family-owners of the
company also take pride with the fact the business has managed to stay constantly debt-free
(long-term debt) for more than a decade or so.
In the same share market, there was an active group of hedge funds that seek for companies
that can be easily turned around to create
additional value. Circling Vulture Fund (CVF) was
one of them. Surely and slowly enough, CVF has recently set its eyes on MB.
At the beginning of 2019, Genghis Smith, the managing partner of CVF projected the future
(debt-free) free cash flows of MB as follows:
Year (End of year) FCF
2019 16.2 mil
2020 18.9mil
2021 21.6 mil
2022 24.3 mil
2023 27.0 mil
2024 29.7 mil
2025 32.4 mil
After 2025, yearly FCFs are projected to be perpetual and stay at 32.4 million $.
The Beta of MB from regression estimation (based on the past three-year daily data) is 0.75.
The relevant risk-free rate and the market risk premium were 5% and 2% respectively. The
treasury department of MB estimates the cost of debt if the company is to borrow to be 5.5%
per year.
As observed in the beginning of 2019, share price of MB was 150 while EPS was 30. The
number of shares outstanding was 5 million shares. The P/E ratio of the slow-growth industry
MB belongs to was only 3.
The corporate tax rate is 21%.
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