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Havem and Needem Companies

7. Havem and Needem companies are exactly the same, differing only in their capital structures. Havem is an unlevered firm issuing only stocks whereas Needem issues stocks and bonds. Neither firm pays corporate taxes. Havem pays out all of its yearly earnings in the form of dividends and has 1 million shares outstanding. Its market capitalization rate is 11% and the firm is currently valued at $180 million. Needem is identical except that 40% of its value is in bonds and has 500,000 shares outstanding. Needem's bonds are risk free and pay a coupon of 9% per year and are rolled over every year.

a. What is the value of Needem's shares?
b. As an investor forecasting the upcoming year, you examine Havem and Needem using three possible states of the economy that are all equally likely: normal, bad, one-half respectively, draw out a distribution table that shows the earnings and the earnings per share for both Havem and Needem.

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