Lecture Note Four_Tsing Hua_2009 - Lecture Note 4 Real...

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Corporate Finance Lecture Note 4 1 Lecture Note 4 Real Options
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Corporate Finance Lecture Note 4 2 What is in This Note? Overview of Merger for Diversification Purposes Overview of Growth Options Reference: Chapter 23 of RWJJ, Chapter 22 of BMA
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Corporate Finance Lecture Note 4 3 Debt and Equity as Options
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Corporate Finance Lecture Note 4 4 Roadmap Viewing Equity as Options: Diversification as a Should a firm do a merger for diversification purposes only? Why or why not? Viewing Debt and Equity as Options: Conflict of Interest between Equity holders and Bondholders Will management ever accept a negative NPV project? If yes, under what circumstances?
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Corporate Finance Lecture Note 4 5 Roadmap Viewing Equity as Options: Diversification as Should a firm do a merger for diversification purposes only? Why or why not?
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Corporate Finance Lecture Note 4 6 Mergers and Diversification Diversification is a frequently mentioned reason for mergers. Diversification reduces risk and, therefore, volatility. Decreasing volatility decreases the value of an option. Assume diversification is the only benefit to a merger: Since equity can be viewed as a call option, should the merger increase or decrease the value of the equity? Since risky debt can be viewed as risk-free debt minus a put option, what happens to the value of the risky debt? Overall, what has happened with the merger and is it a good decision in view of the goal of stockholder wealth maximization?
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Corporate Finance Lecture Note 4 7 Example Consider the following two merger candidates. The merger is for diversification purposes only and with no synergies involved . Risk-free rate is 4%. Company A Company B Market value of assets $40 million $15 million Face value of zero coupon debt $18 million $7 million Debt maturity 4 years 4 years Asset return standard deviation 40% 50%
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8 Example Use the Black and Scholes OPM (or an options calculator) to compute the value of the equity. Value of the debt = value of assets – value of
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Lecture Note Four_Tsing Hua_2009 - Lecture Note 4 Real...

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