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