The current value of levered firm ABC, Inc is $100 million. Its capital structure consists of equity and pure discount debt on which a payment of $80 mn. is due in 5 years. The risk-free rate is 5%
Using the Black-Scholes Option Pricing Model, the value of the firm's equity is (i) if ?=20%, and is (i) if ?=40%. Assuming that the increase in ? was a deliberate action of the firm's management designed to expropriate wealth from bondholders to stockholders, what was the value of this expropriation?
(i) (ii) __(iii)__
a. $40.3 mn. $40.3 mn. $0
b. $33.3 mn. $50.4 mn. $17.1 mn.
c. $33.3 mn. $40.3 mn. $7.0 mn.
d. $40.3 mn. $50.4 mn. $10.1 mn.
(The BSOPM formula and values of the cumulative normal distribution function, must be supplied.)
D
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