Scanlin, inc., currently has an overall value of $5 million. The debt has a face value of $2 million and is represented by discount bonds that mature in three years. The standard deviation of the rate of return on overall firm value is 0.6. The annual risk-free rate is currently 6 percent. Treat the stock as a call option on firm's assets and use the Black-Scholes option pricing model to determine the value of the stock.
A) What is the value of the stock today?
B) What is the value of the implicit put option that debt holders give to shareholders?
C) What is the default risk premium of the debt?
D) If the company issues a subordinated zero coupon debenture with a face value of $1 million and time to maturity of three years. What is the fair market value of the subordinated debenture? Assume that the money raised from issuing the subordinated debenture will be used to retire parts of the existing equity.
E) Suppose that the firm issues zero coupon debentires specified in (D) without subordinating the new bond to the existing bond. What is the amount of wealth transfered from the existing bondholders to the stockholders?