Mini Case:17 - 25h. 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 VolatilitiesVolatility EquityDebt2.121.882.121.882.121.882.121.882.131.872.141.862.161.842.171.832.201.802.221.782.251.752.281.722.311.692.341.662.381.622.411.59The 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.