Reference no: EM13889768
1. Suzhou Corporation is about to launch a new product. Depending on the success of the new product, Suzhou may have one of four values next year: $150 million, $135 million, $95 million, or $80 million. These outcomes are all equally likely, and the risk is completely diversifiable. Assume the risk-free interest rate is 5% and that, in the event of default, 25% of the value of Suzhou's assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.)
a. What is the initial value of Suzhou's equity without leverage? Now suppose Suzhou has zero-coupon debt with a $100 million face value due next year.
b. What is the initial value of Suzhou's debt?
c. What is the yield-to-maturity of the debt? What is its expected return?
d. What is the initial value of Suzhou's equity? What is Suzhou's total value with leverage? Suppose Suzhou has 10 million shares outstanding and no debt at the start of the year.
e. If Suzhou does not issue debt, what is its share price?
f. If Suzhou issues debt of $100 million due next year and uses the proceeds to repurchase shares, what will its share price be? Why does your answer differ from that in part (e)?
2. Nanjing Corp. stock is trading for $25/share. Nanjing has 20 million shares outstanding and a market debt-equity ratio of 0.5. Nanjing's debt is zero-coupon debt with a 5-year maturity and a yield to maturity of 10%.
a. Describe Nanjing's equity as a call option. What is the maturity of the call option? What is the market value of the asset underlying this call option? What is the strike price of this call option?
b. Describe Nanjing's debt using a call option.
3. In 2012, Intel Corporation had a market capitalization of $121 billion, debt of $7.2 billion, cash of $14.7 billion, and EBIT of nearly $18 billion. If Intel were to increase its debt by $1 billion and use the cash for a share repurchase, which market imperfections would be most relevant for understanding the consequence for Intel's value? Why?
4. What are the main advantages and disadvantages of going public?
5. A forward contract is a contract to purchase an asset at a fixed price on a particular date in the future. Both parties are obligated to fulfill the contract. Explain how to construct a forward contract on a share of stock from a position in options.
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