Steinberg Corporation and Dietrich Corporation are identical firms except that D
ID: 2657751 • Letter: S
Question
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 the continuation of the current expansion is 80 percent for the next year, and the probability of a recession is 20 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $4.4 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.8 million. Steinberg's debt obligation requires the firm to pay $980,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.9 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 14 percent.
a-1. What are the current market values of Steinberg's equity and debt? (Enter your answers in dollars, not millions of dollars. Do not round intermediate calculations and round your answers to the nearest whole dollar, e.g., 1,234,567.)
a-2. What are the current market values of Dietrich's equity and debt? (Enter your answers in dollars, not millions of dollars. Do not round intermediate calculations and round your answers to the nearest whole dollar, e.g., 1,234,567.)
Explanation / Answer
(a-1);
Steinberg
Equity value
$2543860
Debt value
$859649
Explanation;
Expansion (80%)
Recession (20%)
EBIT
$4400000
$1800000
Payoff to debtholders
$980000
$980000
Payoff to stockholders
$3420000
$820000
Equity value will be calculated as follow;
($3420000 * 0.8 + $820000 * 0.2) / 1.14
= $2736000 + $164000 / 1.14
= $2543859.65 or $2543860 (Approx.)
Debt value will be calculated as follow;
($980000 * 0.8 + $980000 * 0.2) / 1.14
= $784000 + $196000 / 1.14
= $859649.12 or $859649 (Approx.)
(a-2);
Dietrich
Equity value
$1754386
Debt value
$1649123
Explanation;
Expansion (80%)
Recession (20%)
EBIT
$4400000
$1800000
Payoff to debtholders
$1900000
$1800000
Payoff to stockholders
$2500000
$0
Equity value will be calculated as follow;
($2500000 * 0.8 + $0 * 0.2) / 1.14
= $2000000 + $0 / 1.14
= $1754385.96 or $1754386 (Approx.)
Debt value will be calculated as follow;
($1900000 * 0.8 + $1800000 * 0.2) / 1.14
= $1520000 + $360000 / 1.14
= $1649122.81 or $1649123 (Approx.)
Steinberg
Equity value
$2543860
Debt value
$859649
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.