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Firms ABC and XYZ are identical, except that ABC is more levered. Both firms will remain in business for one more year. It appears that the probability of the continuation of expansion is 75% for the next year and the probability of recession is 25%. If the expansion continues both firms will generate an EBIT of $1 million. If a recession occurs, each firm will generate EBIT of $400’000. ABC’s debt obligation requires the firm to pay $350’000 at the end of the year. XYZ’s debt obligation require the firm to pay $500’000 at the end of the year. Neither firms pay taxes. Assume a discount rate of 15%. Instructions: a. What are the potential pay-offs in one year to ABC shareholders and bondholders ? What about those for XYZ’s ? (10 points)

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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 $3.3 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.7 million. Steinberg's debt obligation requires the firm to pay $960,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.8 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 10 percent.

a-1.

What is the value today of Steinberg's debt and equity? (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32))

Steinberg's
Equity value $
Debt value $
a-2.

What is the value today of Dietrich's debt and equity? (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32))

Dietrich's
Equity value $
Debt value $
b. Steinberg’s CEO recently stated that Steinberg’s value should be higher than Dietrich’s because the firm has less debt and therefore less bankruptcy risk. Do you agree or disagree with this statement?
Disagree
Agree

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 $2.9 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.3 million. Steinberg's debt obligation requires the firm to pay $920,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.4 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 15 percent.

a-1. What is the value today of Steinberg's debt and equity? (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32))

Steinberg's

Equity value $

Debt value $

a-2. What is the value today of Dietrich's debt and equity? (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32))

Dietrich's

Equity value $

Debt value $

b. Steinberg’s CEO recently stated that Steinberg’s value should be higher than Dietrich’s because the firm has less debt and therefore less bankruptcy risk. Do you agree or disagree with this statement?

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 90 percent for the next year, and the probability of a recession is 10 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $4.5 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.9 million. Steinberg's debt obligation requires the firm to pay $990,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $2.0 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 14 percent.

a-1.

What is the value today of Steinberg's debt and equity? (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32))

Steinberg's
Equity value $
Debt value $
a-2.

What is the value today of Dietrich's debt and equity? (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32))

Dietrich's
Equity value $
Debt value $
b. Steinberg’s CEO recently stated that Steinberg’s value should be higher than Dietrich’s because the firm has less debt and therefore less bankruptcy risk. Do you agree or disagree with this statement?
Disagree
Agree

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