13. Equity as an option Aa Aa E Consider the case of Tiny Pigeon Biotech: Tiny Pigeon Biotech is a manufacturing firm. Tiny Pigeon's current value of operations, including debt and equity, is estimated to be $25 million. Tiny Pigeon has $10 million face-value zero coupon debt that is due in two years. The risk-free rate is 5%, and the volatility of companies similar to Tiny Pigeon is 50%. Tiny Pigeon's performance has not been very good as compared to previous years. Because the company has debt, it will repay its loan, but the company has the option of not paying equity holders. The ability to make the decision of whether to pay or not looks very much like an option. Based on your understanding of the Black-Scholes option pricing model (OPM), calculate the following values and complete the table. (Note: Use 2.7183 as the approximate value of e in your calculations.) Values: Tiny Pigeon Biotech Equity value Debt value Debt yield Tiny Pigeon's management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce the company's volatility to 30%. Goals: Tiny Pigeon Biotech Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility Complete the following sentence, assuming that Tiny Pigeon's risk management strategy is successful: If its risk management strategy is successful and Tiny Pigeon can reduce its volatility, the value of Tiny Pigeon's stock will decrease , and the value of its debt will increase 13. Equity as an option Aa Aa E Consider the case of Tiny Pigeon Biotech: Tiny Pigeon Biotech is a manufacturing firm. Tiny Pigeon's current value of operations, including debt and equity, is estimated to be $25 million. Tiny Pigeon has $10 million face-value zero coupon debt that is due in two years. The risk-free rate is 5%, and the volatility of companies similar to Tiny Pigeon is 50%. Tiny Pigeon's performance has not been very good as compared to previous years. Because the company has debt, it will repay its loan, but the company has the option of not paying equity holders. The ability to make the decision of whether to pay or not looks very much like an option. Based on your understanding of the Black-Scholes option pricing model (OPM), calculate the following values and complete the table. (Note: Use 2.7183 as the approximate value of e in your calculations.) Values: Tiny Pigeon Biotech Equity value Debt value Debt yield Tiny Pigeon's management is implementing a risk management strategy to reduce its volatility. Complete the following table, assuming that the goal is to reduce the company's volatility to 30%. Goals: Tiny Pigeon Biotech Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility Complete the following sentence, assuming that Tiny Pigeon's risk management strategy is successful: If its risk management strategy is successful and Tiny Pigeon can reduce its volatility, the value of Tiny Pigeon's stock will decrease , and the value of its debt will increase