Question

Please just need further analysis, thanks

Question: You know that the assets of a firm SKIP are today worth 100mil. You reasonably feel that in a year they will be either worth 110mil or 90mil. You also know that a treasury bill maturing in one year is offering today a yield of 5%. The firm has a zero-coupon bond that matures in one year and has a face value of 100mil. What should be the value of this corporate bond today? What should be its yield to maturity? What should be the value of the equity of the firm? Can you do a further analysis of this problem?

Answer #1

Current value of asset of the firm is 100mil

in 1 year time the value of asset will either be 110 mil or 90 mil.

Therefore, the value of firm can increase or decrase by 10% in 1 year.

Therefore the zero coupon bond of the firm having maturity of 1 year will trade at 10% discount.

Since the maturity value of bond is 100mil therefore current value of bond will be

Value = 100mil - 10%(value)

1.1 Value = 100mil

Value of zero coupon bond = 90.91mil

Yield to maturity (YTM) of this zero coupon bond =

YTM = [(100 mil - 90.91 mil)/100 mil]*100 = 9.09%

Value of equity = Value of total asset - Value of total liability

Value of equity = 100 mil - 90.91 mil = 9.09 mil

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