Treasury bond rate matching maturity of the debt r

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Unformatted text preview: lows from R = r + s s = 12.01% − 10.00% = 2.01% Equities II: R. J. Hawkins Econ 136: Financial Economics 3/ 16 The Contingent-Claim Valuation Paradigm Option input: Equity = C (S , K , σ, r , t ) Value of the assets of the firm (S ). Value of the debt (K ). Variance of the value of the firm (σ ). 2 2 2 2 2 σfirm = wequity σequity + wdebt σdebt + 2wequity wdebt σequity σdebt ρequity,debt Maturity of the debt (t ). Treasury bond rate matching maturity of the debt (r ). Let’s look at some examples! Equities II: R. J. Hawkins Econ 136: Financial Economics 5/ 16 The Contingent-Claim Pricing Paradigm Implications for decision making: the conflict between bondholders and stockholders Mergers, variance, and changes in capital structure Earnings and cash flow variance declines: ρfirm A, firm B = 1. Value of combined equity decreases. Value of combined debt increases since debt is a covered call. Merger of Lube & Auto and Gianni Cosmetics (Damodaran, 2012) Value of firm Value of debt...
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