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A company has a single zero coupon bond outstanding that matures in 10 years and has a

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A company has a single zero coupon bond outstanding that matures in 10 years and has a face value of $10 million. The current value of the company’s assets is $8.8 million, and the standard deviation of the return on the firm’s assets is 47 percent per year. The risk-free rate is 6 percent per year, compounded continuously.

a. What is the current market value of the company’s equity?

b. What is the current market value of the company’s debt?

c. What is the company’s continuously compounded cost of debt?

d. The company has a new project available. The project has an NPV of $1.1 million. If the company undertakes the project, what will be the new market value of equity? Assume volatility is unchanged.

e. Assuming the company undertakes the new project and does not borrow any additional funds, what is the new continuously compounded cost of debt? What is happening here?

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a Using BlackScholes model to value the equity we get d 1 ln880000010000000 06 47 2 2 1047 10608 d 2 ...View the full answer


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Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.

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