Debt and Equity Valuation of it Companies: A Real Option Approach

27 Pages Posted: 4 Dec 2004

See all articles by Chung Baek

Chung Baek

University of Nebraska at Lincoln

Brice V. Dupoyet

Florida International University - College of Business Administration - Finance

Arun J. Prakash

Florida International University (FIU) - Department of Finance; Florida International University

Date Written: September 2004

Abstract

We attempt in this study to estimate the fundamental equity value of a firm by combining two separate capital valuation techniques, namely the corporate debt valuation of Merton (1974) and the rational pricing technique of internet companies of Schwartz and Moon (2000). We use the Black Scholes (1973) approach proposed by Merton (1974) to infer an estimate of the value of the debt of the firm, and the pricing methodology of internet companies pioneered by Schwartz and Moon (2000) to estimate the total value of the firm. Making use of the fact that firm value is made up of debt and equity, we first derive a closed-form solution for the value of the debt and then back out implied fundamental equity values for three firms in the Information Technology sector, and show how in two cases out of three the share price is actually undervalued. We also provide inferences on the debt risk premium.

Keywords: Real options, equity, debt, Black Scholes

JEL Classification: G12, G13, G30, G32

Suggested Citation

Baek, Chung and Dupoyet, Brice and Prakash, Arun Jai, Debt and Equity Valuation of it Companies: A Real Option Approach (September 2004). Available at SSRN: https://ssrn.com/abstract=627064 or http://dx.doi.org/10.2139/ssrn.627064

Chung Baek

University of Nebraska at Lincoln

Lincoln, NE 68583
United States

Brice Dupoyet

Florida International University - College of Business Administration - Finance ( email )

University Park, RB 209 A
11200 SW 8th Street
Miami, FL 33199
United States
305-348-3328 (Phone)
305-348-4245 (Fax)

Arun Jai Prakash (Contact Author)

Florida International University (FIU) - Department of Finance ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

Florida International University ( email )

Miami, FL 33199
United States

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