Principles of Corporate Finance_ 12th Edition

Chapter 23 Credit Risk and the Value of Corporate Debt 617

bre44380_ch23_597-617.indd 617 09/30/15 12:08 PM

The debt has a one-year maturity and a promised interest payment of 9%. Thus, the promised

payment to Backwoods’s creditors is $1,090. The market value of the assets is $1,200 and the

standard deviation of asset value is 45% per year. The risk-free interest rate is 9%. Calculate

the value of Backwoods debt and equity.

16. Default option valuation Use the Black–Scholes model and redraw Figures 23.5 and 23.6
    assuming that the standard deviation of the return on the firm’s assets is 40% a year. Do the
    calculations for 60% leverage only. (Hint: It is simplest to assume that the risk-free interest
    rate is zero.) What does this tell you about the effect of changing risk on the spread between
    high-grade and low-grade corporate bonds? (You may find it helpful to use the Black–Scholes
    program found in the Beyond the Page feature.)

Backwoods Chemical Company (Book Values)

Net working capital $ 400 $1,000 Debt

Net fixed assets 1,600 1,000 Equity (net worth)

Total assets $2,000 $2,000 Total value

CHALLENGE

15. Default option valuation Look back at the first Backwoods Chemical example at the start
    of Section 23-1. Suppose that the firm’s book balance sheet is


16. Go to finance.yahoo.com and select three industrial companies that have been experienc-
    ing difficult times.

a. Are the companies’ troubles reflected in their financial ratios? (You may find it helpful to
refer to Figure 23.8.)

b. Calculate a default probability for each using the formula shown in Section 23-4.

c. Now look at the company’s bond rating. Do the two measures provide consistent messages?

● ● ● ● ●

FINANCE ON

THE WEB

BEYOND THE PAGE

mhhe.com/brealey12e

Try it!

The Black-Scholes

model