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What are the values of the debt and equity today

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Reference no: EM132937836

Assume the assets of a firm will be worth either $100 million or $200 million in 1 year with equal (50%) probability. The firm owes debt holders a payment of $100 million in 1 year. (For convenience assume a discount rate of 0% throughout for all valuations. Absolute priority rules hold, i.e., the debt gets paid first. Hint: Think DCF!)

Problem a. What is the value of the firm today?

Problem b. What are the values of the debt and equity today?

Problem c. Imagine the firm pays stockholders a dividend of $10 million in 1 year (in both states of the world), just before the debt comes due. This dividend payment reduces the value of the assets in 1 year to $90 million and $190 million in the two states. What are the values of the debt and equity today, where the dividend should be included in the equity value?

Problem d. Instead of paying a dividend the firm decides to increase risk, without changing expected asset value. Specifically, the assets will be worth either $80 million or $220 million in the two states. What are the values of the debt and equity?

Reference no: EM132937836

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