a) Harvest Corporation is about to launch a new product. Depending on the success of the new product, the company may have one of four values next year: $150 million, $135 million, $95 million, or $80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 25% of the value of Harvest’s assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.)
The initial value of Harvest Corporation's equity is $ _________ million.
b) Harvest Corporation is about to launch a new product. Depending on the success of the new product, the company may have one of four values next year: $150 million, $135 million, $95 million, or $80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 25% of the value of Harvest’s assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.)
The initial value of Harvest Corporation's debt is $ __________ million.
Feedback for b):Use the weighted average of the possible debt values discounted back one period.