Market value of firm and its debt and equity
Not what you're looking for?
16.2 Steinberg Corporation and Dietrich Corporation are identical firms except that Dietrich is more levered. Both companies will remain in business for one more year. The companies' economists agree that the probability of a recession next year is 20 percent and the probability of a continuation of the current expansion is 80 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $2 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $0.8 million. Steinberg's debt obligation requires the firm to pay $750,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1 million at the end of the year. Neither firm pays taxes. Assume a one-period model, risk neutrality, and an annual discount rate of 15 percent.
a. Assuming there are no costs of bankruptcy, what is the market value of each firm's debt and equity?
b. What is the value of each firm?
c. Steinberg's CEO recently stated that Steinberg's value should be higher than Dietrich's since the firm has less debt, and, therefore, less bankruptcy risk. Do you agree or disagree with this statement?
Purchase this Solution
Solution Summary
The market value of a firm and its debt and equity (for Steinberg Corporation and Dietrich Corporation) are calculated assuming a one-period model and risk neutrality.
Solution Preview
Please see the attached file.
16.2 Steinberg Corporation and Dietrich Corporation are identical firms except that Dietrich is
more levered. Both companies will remain in business for one more year.The companies'
economists agree that the probability of a recession next year is 20 percent and the probability
of a continuation of the current expansion is 80 percent. If the expansion continues,
each firm will generate earnings before interest and taxes (EBIT) of $2 million. If a recession
occurs, each firm will generate earnings before interest and taxes (EBIT) of $0.8 ...
Purchase this Solution
Free BrainMass Quizzes
Organizational Leadership Quiz
This quiz prepares a person to do well when it comes to studying organizational leadership in their studies.
Learning Lean
This quiz will help you understand the basic concepts of Lean.
Employee Orientation
Test your knowledge of employee orientation with this fun and informative quiz. This quiz is meant for beginner and advanced students as well as professionals already working in the HR field.
Change and Resistance within Organizations
This quiz intended to help students understand change and resistance in organizations
Organizational Behavior (OB)
The organizational behavior (OB) quiz will help you better understand organizational behavior through the lens of managers including workforce diversity.