11. Equity as an option Scott Corp. is a manufacturing firm. Scott Corp.’s current value of operations,...

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11. Equity as an option
Scott Corp. is a manufacturing firm. Scott Corp.’s current valueof operations, including debt and equity, is estimated to be $35million. Scott Corp. has $14 million face-value zero coupon debtthat is due in two years. The risk-free rate is 5%, and thevolatility of companies similar to Scott Corp. is 60%. ScottCorp.’s performance has not been very good as compared to previousyears. Because the company has debt, it will repay its loan, butthe company has the option of not paying equity holders. Theability to make the decision of whether to pay or not looks verymuch like an option.
Based on your understanding of the Black-Scholes option pricingmodel (OPM), calculate the following values and complete the table.(Note: Use 2.7183 as the approximate value of e in yourcalculations. Also, do not round intermediate calculations. Roundyour answers to two decimal places.)
Scott Corp. Value (Millions of dollars)
Equity value
Debt value
Debt yield
Scott Corp.’s management is implementing a risk managementstrategy to reduce its volatility. Complete the following table,assuming that the goal is to reduce Scott Corp.’s volatility to30%.
Scott Corp. Goal (Millions of dollars)
Equity value at 30% volatility
Debt value at 30% volatility
Debt yield at 30% volatility
Complete the following sentence, assuming that Scott Corp.’srisk management strategy is successful:
If its risk management strategy is successful and Scott Corp.can reduce its volatility, the value of Scott Corp.’s debt will  , and the value of its stock will   .

Scott Corp. Value (Millions of dollars)
Equity value
Debt value
Debt yield

Scott Corp. Goal (Millions of dollars)
Equity value at 30% volatility
Debt value at 30% volatility
Debt yield at 30% volatility

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11. Equity as an optionScott Corp. is a manufacturing firm. Scott Corp.’s current valueof operations, including debt and equity, is estimated to be $35million. Scott Corp. has $14 million face-value zero coupon debtthat is due in two years. The risk-free rate is 5%, and thevolatility of companies similar to Scott Corp. is 60%. ScottCorp.’s performance has not been very good as compared to previousyears. Because the company has debt, it will repay its loan, butthe company has the option of not paying equity holders. Theability to make the decision of whether to pay or not looks verymuch like an option.Based on your understanding of the Black-Scholes option pricingmodel (OPM), calculate the following values and complete the table.(Note: Use 2.7183 as the approximate value of e in yourcalculations. Also, do not round intermediate calculations. Roundyour answers to two decimal places.)Scott Corp. Value (Millions of dollars)Equity value Debt value Debt yield Scott Corp.’s management is implementing a risk managementstrategy to reduce its volatility. Complete the following table,assuming that the goal is to reduce Scott Corp.’s volatility to30%.Scott Corp. Goal (Millions of dollars)Equity value at 30% volatility Debt value at 30% volatility Debt yield at 30% volatility Complete the following sentence, assuming that Scott Corp.’srisk management strategy is successful:If its risk management strategy is successful and Scott Corp.can reduce its volatility, the value of Scott Corp.’s debt will , and the value of its stock will .