Higgs Bassoon Corporation is a custom manufacturer of bassoons and other wind instruments. Its current value of operations, which is also its value of debt plus equity, is estimated to be $200 million. Higgs has zero coupon debt outstanding that matures in 3 years with $110 million face value. The risk-free rate is 5%, and the standard deviation of returns for similar companies is 60%. The owners of Higgs Bassoon view their equity investment as an option and would like to know its value. Start with the partial model in the file Ch17 P13 Build a Model.xls on the textbook’s Web site and answer the following questions:
a. Using the Black-Scholes option pricing model, how much is the equity worth?
b. How much is the debt worth today? What is its yield?
c. How would the equity value change if Fethe’s managers could use risk management techniques to reduce its volatility to 45%? Can you explain this?
d. Graph the cost of debt versus the face value of debt for values of the face value from $10 to $160 million.
e. Graph the values of debt and equity for volatilities from 0.10 to 0.90 when the face value of the debt is $100 million.
Graphs are mandatory.