Sunburn Sunscreen has a zero coupon bond issue outstanding with a $20,000 face v

Question

Sunburn Sunscreen has a zero coupon bond issue outstanding with a $20,000 face value that matures in one year. The current market value of the firm’s assets is $23,200. The standard deviation of the return on the firm’s assets is 27 percent per year, and the annual risk-free rate is 6 percent per year, compounded continuously. Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $45,000 that matures in one year. The current market value of the firm’s assets is $48,600. The standard deviation of the return on the firm’s assets is 35 percent per year. Suppose Sunburn Sunscreen and Frostbite Thermalwear have decided to merge. Because the two companies have seasonal sales, the combined firm’s return on assets will have a standard deviation of 18 percent per year.

a. What is the combined value of equity in the two existing companies?

a 2. What is the combined value of debt in the two existing companies?

b. What is the value of the new firm’s equity?

b 2. What is the value of the new firm’s debt?

c. What was the gain or loss for shareholders?

c 2. What was the gain or loss for bondholders?

Explanation / Answer

a) ans:-Present market values of the two companies =$23,200 +$48,600

=$71800.

a2)ans:- combined debt value of the two companies =$3200 +$3600 =$6800

b) ans:- Equity of the new firm = $71800.

b2) ans:- equity of the new firm debt is = $6800

c) ans :- Gain = $65000-$71800=$ 6800

c2)ans :- bond holders get 18% of gain

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