Steinberg Corporation and Dietrich Corporation are identical firms except that D

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 70 percent for the next year, and the probability of a recession is 30 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $2.8 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.2 million. Steinberg's debt obligation requires the firm to pay $910,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.3 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 12 percent. What are the current market values of Dietrich's equity and debt?

Explanation / Answer

Market value of Dietrich's Equity {.70(2800000-1300000)+0.30(0)}/1.12=937500 Market value of Dietrich's Debt {.70(1300000)+.30(1200000)}/1.12=1133929

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.