Question
Your boss now wants you to helpHiggsBassoon Corporation.HiggsBassoon Corporation is a custom manufacturer of bassoons and other wind instruments. Its current value of operations, which
Your boss now wants you to helpHiggsBassoon Corporation.HiggsBassoon Corporation is a custom manufacturer of bassoons and other wind instruments. Its current value of operations, which is also its value of debt plus equity, is estimated to be $200 million.Higgshas zero coupon debt outstanding that matures in 3 years with $110 million face value. The risk-free rate is 5%, and the standard deviation of returns for similar companies is 60%. The owners ofHiggsBassoon view their equity investment as an option and would like to know its value. Start with the attachedpartial model, and answer the following questions:
- Using the Black-Scholesoption pricing model, how much is the equity worth?
- How much is the debt worth today? What is its yield?
- How would the equity value change if the company used risk management techniques to reduce its volatility to 45%? Can you explain this?
- Graph the cost of debt versus the face value of debt for values of the face value from $10 to $160 million.
- Graph the values of debt and equity for volatilities from 0.10 to 0.90 when the face value of the debt is $100 million.
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