XYZ Corporation has $500 million in zero-coupon debt outstanding, due in five years. The firm had earnings before interest and taxes of $40 million in the most recent year (the tax rate is 40%).
These earnings are expected to grow 5% a year in perpetuity, and the firm paid no dividends.
The firm had a cost of equity of 12% and a cost of capital of 10%. The annualized standard deviation in firm values of comparable firms is 12.5%. The five-year bond rate is 5%.
A. Estimate the value of the firm.
B. Estimate the value of equity, using an option pricing model.
C. Estimate the market value