Avia plc is considering a new risky venture. Depending on the success of the project the company’s value at the end of the year may be one of the four following, equally likely values $150m, $135m, $95m or $80m. The risk of this venture is diversifiable. In the event of default, 25% of the value of the asset value will be lost due to the cost of bankruptcy. The risk-free interest rate is 5%. Consider three possible scenarios: 

Case 1: Avia plc has no leverage. 

Case 2: Avia plc has a zero-coupon bond with face value $100m due next year.

 Case 3: Avia plc has 10m shares outstanding and no debt at the start of the year. Required:

Case 1:

1) Estimate the value of Avia plc’s equity.

In case 2:

2) Estimate the initial value of Avia plc’s debt.

3) What is the YTM of Avia plc’s bond?

4) What is the expected return of Avia plc’s bond?

5) What is the value of Avia plc’s equity?

6) What is the total value of Avia plc with leverage?

In case 3:

7) What is the share price of Avia plc, without debt?

8) If Avia plc issue $100m debt due next year and uses the proceeds to repurchase shares, what will its share price be? Why does the answer differ from the answer in 6) above?

Answer rating: 100% (QA)

Case 1 Avia plc has no leverage 1 Estimate the value of Avia plcs equity Since Avia plc has no debtthe value of its equity is equal to the value of th... View the full answer