What if Ls debt is risky? For the purpose of this example, assume that the value of
Question:
What if L’s debt is risky? For the purpose of this example, assume that the value of L’s operations is $4 million—which is the value of its debt plus equity. Assume also that its debt consists of 1-year zero coupon bonds with a face value of $2 million. Finally, assume that L’s volatility is 0.60 (( = 0.60) and that the risk free rate is 6 percent.
MINI CASE
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies average about 30 percent debt, and Mr. Lyons wonders why they use so much more debt, and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: |
When companies need to raise money, issuing bonds is one way to do it. A bond functions as a loan between an investor and a corporation. The investor agrees to give the corporation a specific amount of money for a specific period of time in exchange... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the...
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Ls equity can be considered as a call option on the total value of l with an exercise price of 2 mil...View the full answer
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Related Book For 
Financial management theory and practice
ISBN: 978-0324422696
12th Edition
Authors: Eugene F. Brigham and Michael C. Ehrhardt
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