Explanation:
Value of equity = max(V − F, 0)
= max(35 − 25, 0)
= 10 million
Value of debt = F − max(F − V, 0)
= 25 − max(25 − 20, 0)
= 25 − 5
= 20 million
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Q.2670 Use the simple Merton model to find the value of a firm’s equity and debt in the following scenarios.
I. The principal amount due on the firm’s debt is $25 million and the value of the firm is $35 million. Find the value of the firm’s equity.
II. The principal amount due on the firm’s debt is $25 million and the value of the firm is $20 million. Find the value of the firm’s debt.
A
$10 million and 0
B
0 and $10 million
C
$10 million and $20 million
D
$20 million and $10 million
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