Question

Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of Buckeye’s assets is currently $1,200. Urban Meyer, the CEO, believes that the assets in the firm will be worth either $950 or $1,470 in a year. The going rate on one-year T-bills is 2 percent.

  

a-1	What is the value of the company’s equity? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Value of equity

$

  

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

  

Value of debt

$

  

Suppose the company can reconfigure its existing assets in such a way that the value in a year will be $910 or $1,710.

   

b.	If the current value of the assets is unchanged, what is the new value of the company's equity? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

   

Value of equity

$

Answer 1

Value of Debt today = $1,000 (a-2)

since value of debt = Interest[(1 – (1/((1 + Kd)^t)))/Kd] + [FV/((1 + Kd)^t)] where Kd = cost of debt and t = time period of the debt

=20*((1-(1/((1+0.02)^1)))/0.02) + =1000/(1+0.02)^1 = 1,000

Value of Equity = Total Assets - Value of Debt = $1,200 - $1,000 = $200 (a-1)

Based on the information provided, in one year, value of debt = $1,000 + Interest Accrued, i.e. $1,020 (a-2)

If total assets = $950, equity = $950 - $1,020 = -$70 (a-1)

If total assets = $1,470, equity = $1,470 - $1,020 = $450 (a-1)

If value of total assets after one year = $910, equity is extinguished since $910 - $1,020 = -$110

If value of total assets after one year = $1710, equity is $1,710 - $1,020 = $690

If current value of assets is unchanged, assets = $1,200, debt = $1,000; therefore value of equity is unchanged at $200