Computation of interest rate and current value of debt

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Reference no: EM1310393

Computation of interest rate and current value of debt and equity.

Rackin Pinion Corporation's assets are currently worth $900. In one year, they will be worth either $600 or $1200. The risk-free interest rate is 5 percent. Suppose Rackin Pinion has an outstanding debt issue with a face value of $600.

(a) What is the current value of the debt? The interest rate of the debt?

(b) What is the current value of the equity?

(c) Rackin issues a new corporate bond with a face value of $200. If the bond is junior to the existing debt, i.e., paid only after the existing debt holders are paid in full. What is value of the new bond? What is the appropriate interest rate?

(d) In part (c), what is the value of existing debt and equity?

(e) In part (c), assume instead the new bond is senior to the existing debt (i.e., paid in full before the existing debt holders are paid anything). What is the value of new bond and the corresponding interest rate?

(f) In part (e), what is the value of existing debt and equity?

Reference no: EM1310393

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