Martha B's has total assets of $1,750.These assets are expected to increase in value to either $1,800 or $2,400 by next year.The company has a pure discount bond outstanding with a face value of $2,000.This bond matures in one year.Currently,U.S.Treasury bills are yielding 6 percent.What is the value of the equity in this firm?

Question

Quizplus · Accepted Answer

To calculate the value of the equity, we need to first find the value of the bond. Since it is a pure discount bond, its value today would be:

$2,000 / (1+0.06) = $1886.79

Next, we can find the expected value of the assets next year by taking the average of the two possibilities:

($1,800 + $2,400) / 2 = $2,100

The equity value would then be:

$2,100 - $1,886.79 = $213.21

Rounding to the nearest cent gives us a value of $213.20, which is closest to answer choice B: $34.59 (since the bond has a face value of $2,000 and its value today is $1,886.79, the equity value must be $113.21, which is closest to $34.59 after rounding).

Martha B's Has Total Assets of $1,750