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Chocolate Ice Cream Co and the Vanilla Ice Cream Co

The Chocolate Ice Cream Co. and the Vanilla Ice Cream Co. have agreed to merge and form the Fudge Swirl Consolidated. Both companies are exactly alike except that they are located in different towns. The end-of-period value of each firm is determined by the weather, as shown below. There will be no synergy to the merger.

State Probability Value
Rainy .1 $100,000
Warm .4 $200,000
Hot .5 $400,000

The weather conditions in each town are independent of those in the other. Furthermore, each company has an outstanding debt claim of $200,000. Assume that no premiums are paid in the merger.

What are the possibile values of the combined company?

What are the possible values of end of period debt values and stock values after the merger?

Show that the bondholders are better off and the stockholders are worse off in the combined firm than they would have been if the firms had remained separate?

Solution Preview

What are the possibile values of the combined company?

Possible values of the combined firm are
Weather in Chocolate State Weather in Vanilla State Probability value
Rainy Rainy 0.01 200000
Rainy Warm 0.04 300000
Rainy Hot 0.05 500000
Warm Rainy 0.04 300000
Warm Warm 0.16 400000
Warm Hot 0.20 600000
Hot Rainy ...

Solution Summary

Chocolate Ice Cream Co and Vanilla Ice Cream Co are examined. The end-of-period value of the firms is determined. The debt and stock values after the merger is determined.

$2.19