10.4  Example 1

Suppose the underlying asset value of firm =$100M and the face amount of the outstanding debt is $150M.  Can this stock trade at a positive price?  Suppose the bond is due in 5 years, the risk free interest rate is 5%, and the volatility of assets is

Option pricing has six inputs into the valuation model and we assume the following inputs for this example:

A = $100 million

sA = 90%.

Strike price =$150 million

T = 5-years

Risk free rate = 5%

Shares outstanding 100 million

Current Market Price per share is $0.50

Let’s calculate the value of this stock using Valuation Tutor.  Select the “

 

And enter the parameters (on a per-share basis) to get:

:

The value of the stock is just over 66c, so the market capitalization of the stock is 66m; this also implies that the value of the debt is $150M - $66.082 = $83.919m.