Equity as an Option Rackin Pinion Corporation's assets are currently worth $1,100. In one year, they will be worth either $1,000 or $1,300. The risk-free interest rate is 5 percent. Suppose Rackin Pinion has an outstanding debt issue with a face value of $1,000.

a. What is the value of the equity?

b. What is the value of the debt? The interest rate on the debt?

c. Would the value of the equity go up or down if the risk-free rate were 20 percent? Why? What does your answer illustrate?

Equity as an Option Volunteer Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value of Volunteer's assets is currently $1,200. Phil Fulmer, the CEO, believes that the assets in the firm will be worth either $800 or $1,400 in a year. The going rate on one-year T-bills is 4 percent.

a. What is the value of Volunteer's equity? The value of the debt?

b. Suppose Volunteer can reconfigure its existing assets in such a way that the value in a year will be $500 or $1,700. If the current value of the assets is unchanged, will the stockholders favor such a move? Why or why not?

Calculating Conversion Value A $1,000 par convertible debenture has a conversion price for common stock of $125 per share. With the common stock selling at $90, what is the conversion value of the bond?

Convertible Bonds The following facts apply to a convertible bond making semiannual payments:


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Conversion price


Coupon rate


Par value


Yield on nonconvertible debentures

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