Spreadsheet 6f2 Total Firm Value < Total debt???

[Irfan]

Hi David,
The firm value of 120 is less than the total debt value in this spreadsheet? I am presuming that we are not assuming KMV application of 0.5 times debt in this example. Can you please explain why that is so?
Many thanks in advance.
Irfan

 

[David Harper CFA FRM]

Hi Irfan,

That's from Stulz' example ... I should make the labels better
F = 100 and U = 50 are face (principal) value of debt, so the "current" capital structure implied by the merton model is:
(and the point of the model is to use Merton to infer the prices)
subord = 23.8, senior = 59.6, = equity 36.5 for total value = 120
(agreed, the 0.5 would not enter here b/c this is "straight Merton" not KMV's adaption of)

David