Question
LMI Industries is a highly leveraged firm and there is a high probability that it will default on its debt. The value of LMIs operations
LMI Industries is a highly leveraged firm and there is a high probability that it will default on its debt. The value of LMIs operations is $5 Million. The companys debt consists of 1-year, zero coupon bonds with a face value of $2.5 Million. LMIs volatility () is 0.60 and the risk-free rate (rRF) is 5%. As LMIs debt is very risky, its equity is comparable to a call option that can be valued using the Black-Scholes OPM. Thus, please address the following:
1. What is the value of LMIs stock and debt?
2. What is the yield on LMIs debt
3. What would be the value of LMIs stock, debt, and yields and debt, for different volatilities of 0.40 and 0.80?
4. What are some incentives for the CFO of LMI if they understand the relationship between equity value and volatility?
5. What are some options (if any) for shareholders, given the overall circumstances including likely CFO actions?
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