Explanation:
Under Merton's model, the value of the firm's debt can be modeled as a risk-free bond minus a put option on the firm's assets. When the time to maturity lengthens, the time value of the put option generally increases, which subtracted from the debt leads to a decrease in the value of the debt. Additionally, a longer discount period reduces the present value of the risk-free payment, further decreasing the debt's value. Increasing firm volatility increases the value of the put option (reducing debt value), reducing the face amount directly reduces the debt value, and increasing interest rates decreases the present 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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