Question

APP’s capital structure is made of 500,000 shares of common stock and of 50,000 bonds. Currently, one share trades at $40. The debt instrument is zero-coupon bond maturing in exactly 2 years, each with a face value of $1,000. Historically, the assets in this industry have achieved a return with a volatility of 25%. The interest rate for a Treasury bond maturing in 2 years’ time is 4% per year. Explain how to determine the current value of the firm’s assets.

Answer 1

To determine the current value of the firm's assets, multiply the current share price by the number of shares for the common stock and calculate the present value of the bond payments for the bonds. Then, add the present values of both the common stock and the bond payments to find the total value of the firm's assets.

Step-by-step explanation:

To determine the current value of the firm's assets, we need to calculate the present value of both the common stock and the bonds. The present value of the common stock can be found by multiplying the current share price by the number of shares. In this case, the present value of the common stock is $40 x 500,000 = $20,000,000.

For the bonds, we need to calculate the present value of the bond payments and the principal repayment. Since the zero-coupon bonds have no coupon payments, the present value of the bond payments is simply the face value of the bond. Thus, the present value of the bond payments is $1,000 x 50,000 = $50,000,000.

The total value of the firm's assets is the sum of the present values of the common stock and the bond payments. Therefore, the current value of the firm's assets is $20,000,000 + $50,000,000 = $70,000,000.