Explanation:
According to the Merton model, the value of risky debt can be evaluated as a risk-free bond minus a put option on the firm's assets. Lengthening the time to maturity reduces the present value of the risk-free bond and generally increases the value of the put option, both of which decrease the value of the firm's debt. Equivalently, a longer time to maturity introduces greater exposure to default risk, reducing the current value of the debt.
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Q.63 Understanding the value of debt is crucial for both financial management and strategic planning. Debt financing involves borrowing funds that must be repaid over time with interest. For a firm financed partly by debt and partly by equity, the value of debt:
A
increases if the volatility of the firm increases.
B
increases if the face amount of debt falls.
C
falls if its time to maturity lengthens.
D
increases if the interest rate increases.
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