Formulas

Question 1

Firm value

Answer 1

Question 2

Pro forma sheets

Answer 2

Question 3

Cost of equity

Answer 3

Question 4

WACC Formulas

Answer 4

Question 5

Option pricing of V = E + D

Answer 5

If debt is risky, there may be two outcomes.

1. V>=D -> promised payment made in full
2. V<d> Defaulting on payment</d>

==> Actual payment to debt: min(D,V) (assume limited liability)
-> If we have a put option to sell for D, the payout is max(0,D-V)

Debt: min(D,V) = D - max(0, D-V),
where D is riskless debt, and the rest is a short put option.

Equity: Call option on firm equity, max(0, V-D)

We can see that this is V in all cases;
1) V>=D, E+D = V-D+D-0 = V
2) V<d>
</d>

Question 6

Formulas for instaneous Betas

S = Equity, B = Debt

Answer 6