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11. Equity as an option

Scott Corp. is a manufacturing firm. Scott Corp.'s current value of operations, including debt and equity, is estimated to be $15 million. Scott Corp. has $6 million face-value zero coupon debt that is due in five years. The risk-free rate is 5%, and the volatility of companies similar to Scott Corp. is 50%. Scott Corp.'s performance has not been very good as compared to previous years. Because the company has debt, it will repay its loan, but the company has the option of not paying equity holders. The ability to make the decision of whether to pay or not looks very much like an option.

Based on your understanding of the Black-Scholes option pricing model (OPM), calculate the following values. (Note: Use 2.7183 as the approximate value of e in your calculations. Also, do not round intermediate calculations. Round your answers to two decimal places.)

Scott Corp. Value (Millions of dollars)

Equity value?

Debt value?

Debt yield? 

Scott Corp.'s management is implementing a risk management strategy to reduce its volatility. Assuming that the goal is to reduce Scott Corp.'s volatility to 30%.

Scott Corp. Goal (Millions of dollars)

Equity value at 30% volatility?   

Debt value at 30% volatility?

Debt yield at 30% volatility?