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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 ).
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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- Fall '08