Question

Rackin Pinion Corporation’s assets are currently worth $1,065. In one year, they will be worth either $1,000 or $1,340. The risk-free interest rate is 3.9 percent. Suppose the company has an outstanding debt issue with a face value of $1,000.

a.	What is the value of the equity? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b-1.	What is the value of the debt? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b-2.	What is the interest rate on the debt? Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

c.	Would the value of the equity go up or down if the risk-free rate were 20 percent?

Answer 1

a) Calculating value of the equity

value of equity

= $1,065 - 1000/(1+3.9%)

=$1,065 - 1000/(1+0.039)

=$1,065 - 1000/(1.039)

=$1,065 - 962.46

= $102.54

b1) Calaculating value of the debt

= 1065 - 102.54

= 962.46

b2) Calculating interest rate on the debt

= 1000/ 962.46 - 1

=1.03900421836-1

=0.03900421836

=3.9%

interest rate =3.9%

C)

Increase or Up

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