Arley Merchandise Corporation Case Study Analysis Help With Solution

Posted on March 16, 2017

Arley Merchandise Corporation Case Study Analysis Help With Solution

 
Arley Merchandise Corporation
 
Some Pointers
 
Assuming Arley’s common stock, would sell at $6.50 per share in the public
market, is the proposed “money-back guarantee” likely to have sufficient
value to bridge the $1.50 gap noted in the case?
 
As indicated in the presentation, you can break down the market value of the unit
as follows:
 
Market Value of the Unit
=Market Value of Stock + Market Value of Put Option
=Market Value of Zero-Coupon Bond + Market Value of Call Option
 
Use Black-Scholes to solve for these components. Black-Scholes is covered in
Chapter 6 of the Lacey text.
 
Why is the alternative of meeting the money-back guarantee by issuing a tenyear
note included in the proposal. How does this affect the value of the
guarantee to purchasers?
 
You want to address the issue of information asymmetry
How does the proposed Arley security differ from a convertible subordinated
debenture?
 
In explaining the differences you want to address the conversion period, the rate of
interest paid and the life of the issue.

 

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Questions
 
Assuming Arley’s common stock, would sell at $6.50 per share in the public market, is the proposed “money-back guarantee” likely to have sufficient value to bridge the $1.50 gap noted in the case?
 
(Note: In October, 1984, the two-year Treasury strip rate was about 11% per annum. The price volatility of publicly-traded common stocks similar to Arley was estimated at a standard deviation of 40% per annum.)
 
Why is the alternative of meeting the money-back guarantee by issuing a ten-year note included in the proposal. How does this affect the value of the guarantee to purchasers?
 
How does the proposed Arley security differ from a convertible subordinated debenture?
 
Market Value of the Unit
 
Market Value of Stock + Market Value of Put Option
 
Market Value of Zero-Coupon Bond + Market Value of Call Option

 

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