A firm has a market value of $12 million and outstanding debt of $10 million that matures in 2 years. The firm asset grows at a rate of 6% with a standard deviation of 15%, and the risk-free rate is 5% with continuous compounding. 

(a) What is the fair value of the equity? 

(b) Express the market value of the debt as a function of a put option on the firm’s asset. 

(c) If the risk-free rate is 10% and everything else is unchanged, will the market value of equity and the market value of debt be changed? How? Please assist with explanation and another thought- is the growth rate insignificant in this question?

Answer rating: 100% (QA)

a The fair value of the equity is 2 million 12m 10m 2m b The market va... View the full answer