IX. SmartOptions, Inc. (SO) currently has no debt. Its assets will be worth $800

Question

IX. SmartOptions, Inc. (SO) currently has no debt. Its assets will be worth $800 million in one year if the economy is strong, but only $300 million in one year if the economy is weak. Both events are equally likely. Assume its cost of capital is determined to be 10%. 1. Find the market value (i.e. the price today) of SO's assets. 2. Now assume SO recapitalizes by issuing debt. First, a senior bond for $300 million dollars with a promised rate of 10%. Second, a junior bond for $100 illion which promis of capital under the recapitalized capital structure.

Explanation / Answer

Question 1). Solution :- Calculation of the market value of assets of SmartOptions Inc, as on the today :-

= (800 Million * 0.50 + 300 Million * 0.50) / (1 + 0.10)1

= (400 Million + 150 Million) / (1.10)1

= 550 Million / 1.10

= $ 500 Million.

Conclusion :- Market value of the assets of SmartOptions Inc, as on the today = $ 500 Million.

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