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Suppose a firm has two debt issues outstanding. One is a senior debt issue that matures in three years with a principal amount of $100 million. The other is a subordinate debt issue that also matures in three years with a principal amount of $50 million. The annual interest rate is 5 percent and the volatility of the firm value is estimated to be 15 percent. In the Merton model the value of equity is calculated as:
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