Problem I: (25 marks)

North Technology Inc. has a zero-coupon bond that matures in five years with a face value of $60,000. The current value of the company's asset is $57,000 and the standard deviation of rate of return on assets is 50% per year. The continuously compounded risk-free rate of interest is 6%.

• What are the market values of the company's debt and equity? (6 marks)
• What is the yield to maturity on North Technology's debt? (6 marks)
• What is the value of shareholders' limited liability? (6 marks)
• Suppose the company can re-structure its balance sheet so that the standard deviation of its return on assets increases to 60% per year. Assuming all other things remaining the same, who (shareholders vs. bondholders) benefits from the restructuring and why? What are the magnitudes of loss/gain to each type of stakeholders? Show your calculations. (7 marks)