Overhang Development Corp., currently has assets with a market value of $100. Next year the market value of Overhang Development's assets is going to increase by 10% or decrease by 30% depending on the state of the economy. The annual risk-free rate of interest is 0%. Overhang Development Corp. has one share of equity issued and outstanding as well as one zero-coupon corporate bond outstanding with a face value of $100 which matures next year and is neither callable/puttable nor convertible.

(a)  Find:

(i)  the intrinsic value of Overhang Development's corporate bond;

(ii)  the intrinsic value of the equity share;

(iii)  the promised yield to maturity of the corporate bond;

(iv)  the credit spread of the corporate bond.

(b) Suppose a new project comes along which requires $20 as an initial investment. The project has the same returns as the existing assets of the firm, an NPV = 0 and will be financed entirely with a new equity issue. How would your answers to part (a) change if this new investment opportunity is undertaken by Overhang Development Corp.?

(c)  How would your answers to part (b) change if Overhang Development Corp. uses debt financing to fund the new project?

Answer rating: 100% (QA)

a Find i 2 points the intrinsic value of Overhang Developments corporate bond ANSWER The intrinsic value of the bond is 100 EXPLANATION The corporate ... View the full answer