Your company has a single zero coupon bond outstanding that matures in five years with a face value of $35 million. The current value of the company's assets is $25 million, and the standard deviation of the return on the firm's assets is 43 percent per year. The risk-free rate is 6 percent per year, compounded continuously. Use Merton's option based structural model to answer the following questions:
1. What is the current market value of the company's equity?
2. What is the current market value of the company's debt?
3. What is the company's continuously compounded cost of debt?
4. What is the credit spread on the firm's debt?
5. What is the associated approximate probability of default?
You are evaluating a new project for your company. You estimate that the project has an NPV of $2,400,000.
6. If your company undertakes the project, what will be the new market value of equity? Assume volatility of assets is unchanged at 43%.
7. If your company undertakes the new project and does not borrow any additional funds, what is the new continuously compounded cost of debt?
8. What is the new credit spread on the firm's debt?
9. What is the associated approximate probability of default?
10. explain the change that is introduced by the new project.