Consider a two-date binomial model

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Consider a two-date binomial model. A company has both debt and equity in its capital structure. The value of the company is 100 at Date 0. At Date 1, it is equally like that the value of the company increases by 20% or decreases by 10%. The total promised amount to the debtholders is 100 at Date 1. The riskfree interest rate is 10%.

a. What is the value of the debt at Date 0? What is the value of the equity at Date 0?

b. Suppose the government announces that it guarantees the company’s payment to the debtholders. How much is the government guarantee worth?

Reference no: EM131354248

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