Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of the company’s assets is currently $1,200. Urban Meyer, the CEO, believes that the assets in the company will be worth either $950 or $1,470 in a year. The going rate on one-year T-bills is 2 percent.
a-1). Value of Assets = [E0 * {(Higher level of Asset in a year - Lower level of Asset in a year) / (Higher level of Asset in a year - Face Value)}] + [Lower level of Asset in a year / (1 + rF)]
$1,200 = [E0 * {($1,470 - $950) / ($1,470 - $1,000)}] + [$950 / (1 + 0.02)]
$1,200 = [E0 * {$520 / $470}] + [$950 / (1 + 0.02)]
$1,200 = [E0 * 1.1064] + $931.37
$1,200 - $931.37 = E0 * 1.1064
$268.63 = E0 * 1.1064
E0 = $268.63 / 1.1064 = $242.80
a-2). Value of Debt = Assets Value - Value of Equity = $1,200 - $242.80 = $957.20
b). Value of Assets = [E0 * {(Higher level of Asset in a year - Lower level of Asset in a year) / (Higher level of Asset in a year - Face Value)}] + [Lower level of Asset in a year / (1 + rF)]
$1,200 = [E0 * {($1,710 - $910) / ($1,710 - $1,000)}] + [$950 / (1 + 0.02)]
$1,200 = [E0 * {$800 / $710}] + [$910 / (1 + 0.02)]
$1,200 = [E0 * 1.1268] + $892.16
$1,200 - $892.16 = E0 * 1.1268
$307.84 = E0 * 1.1268
E0 = $307.84 / 1.1268 = $273.21
Buckeye Industries has a bond issue with a face value of $1,000 that is coming due...
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