fm17 25 - h What is the value of Ls stock for volatilities...

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Mini Case: 17 - 25 h. What is the value of L’s stock for volatilities between 0.20 and 0.95? What incentives might the manager of L have if she understands this relationship? What might debtholders do in response? Answer: The mini case model shows the calculations for the table below. Value of Stock and Debt for Different Volatilities Volatility Equity Debt 2.12 1.88 2.12 1.88 2.12 1.88 2.12 1.88 2.13 1.87 2.14 1.86 2.16 1.84 2.17 1.83 2.20 1.80 2.22 1.78 2.25 1.75 2.28 1.72 2.31 1.69 2.34 1.66 2.38 1.62 2.41 1.59 The value of the equity increases as the volatility increases—and the value of the debt decreases as well. A manager who knows this may choose to invest the proceeds from borrowing in assets that are riskier than usual.
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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