QUESTION 1a [10 Marks]

The market value of the assets of a corporation is currently $15 million. The firm has on issue a debt outstanding that has a par value of $13.2 million and a due date of exactly five years. No intermediate interest payments are required. The risk-free (continuous) rate is 5.5% and the standard deviation of returns of the firm's assets is 60%.

Fortunately, for the bank loan officer, she learns that a dividend of $1.2 million will be paid within days. (Hint: It can be assumed that the dividend will be paid immediately.)

What should be the today's equity value and debt value and the fair interest rate required by the debt holders? State any simplifying assumptions made in your calculations.