Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

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underlyingasset mayincrease abovethestrikepricein the
remaining lifetime of the option, equity commands value
becauseofthetimepremiumontheoption(thetimeuntilthe
bondsmatureandcomedue)andthepossibilitythatthevalue
oftheassetsmayincreaseabovethefacevalueofthebonds
before they come due.


ILLUSTRATION 17.9: Firm Value and Equity Value


Revisitingthepreceding example,assume thatthevalue of
thefirmdropsto$50 million,belowthefacevalue ofthe
outstanding debt ($80 million). Assume that all the other
inputsremainunchanged.Theparametersofequityasacall
option are:


Basedontheseinputs,theBlack-Scholesmodelprovidesthe
following value for the call:


Aswecansee,theequityinthisfirmretainsvaluebecauseof
theoptioncharacteristicsofequity.Infact,equitycontinues
tohavevalueinthisexampleevenifthefirmvaluedropsto
$10 million or below, as shown inFigure 17.2.


FIGURE 17.2Value of Equity as Firm Value Changes

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