Explanation:
The payoff to debt holders = Max[Value of the firm or (Value of the firm − value of debt)]
= [70 or (70 − 95)] = $70 million
Payoff to the equity holder is
Since all the value goes to the payment of the debt, the equity holders get nothing.
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Q.3058 James Rodrigues is a risk analyst at a local Dutch firm. Using the Merton model he estimates the value of the firm to be $70 million at the time when its debt matures. The face value of firm’s debt is $95 million. The payoff to the debt holders and equity holders at the time of maturity respectively are closest to:
A
$70 million to debt holders and $0 to equity holders
B
$0 to debt holders and $70 million to equity holders
C
$95 million to debt holders and $0 to equity holders
D
$70 million to Ddebt holders and $25 million to equity holders