You estimate that Amabo Inc. has a current total asset value of $187 million, and that its asset volatility is 14% per annum on a continuous annual basis. The risk-free rate is 2.5%, and the expected return on Amabo assets is 9% (rates are on a per annum continuously compounded basis). The firm pays no dividends. This highly levered company has $100 million face value of senior debt coming due in 5 years, and $40 million face value of junior debt also coming due in 5 years. The junior debt will only receive payment after the senior debt is paid in full. The rest of the capital structure is equity.

Use Merton's model to estimate the current value of the junior debt.

Answer rating: 100% (QA)

Inputs Total asset value 187 million Asset volatility 14 per annum Riskfree rate 25 per annum Expect... View the full answer