Digital Organics has 11.1 million outstanding shares trading at $36 per share. I

Question

Digital Organics has 11.1 million outstanding shares trading at $36 per share. It also has a large amount of debt outstanding, all coming due in one year. The debt pays interest at 9%. It has a par (face) value of $339 million, but is trading at a market value of only $291 million. The one-year risk-free interest rate is 7%.

a. Complete the put–call parity formula for Digital Organics’ stock, debt, and assets.

Equity + PV (Debt, at risk-free rate)= Default Options +Assets

Equity-

PV-

Default Option-

Assets-

b. What is the value of the company’s option to default on its debt? (Enter your answer in millions.)

Explanation / Answer

Equity = 11.Mn *36 =399.6 Mn

Debt at risk free rate =339/1.07 =316.88

Assets = Market value of Debt + Equity

=399.6+291 =690.6

Now value of default option =399.6 +316.88 =716.48

value fo default option = 716.8 - 690.6

=25.88

Vaue of default option = 316.88 -291

= 25.88

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