Question

Steinberg Corporation and Dietrich Corporation are identical companies 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 company will generate earnings before interest and taxes (EBIT) of $3.4 million. If a recession occurs, each company will generate earnings before interest and taxes (EBIT) of $1.8 million. Steinberg's debt obligation requires the company to pay $970,000 at the end of the year. Dietrich's debt obligation requires the company to pay $1.9 million at the end of the year. Neither company pays taxes. Assume a discount rate of 12 percent.

a-1.

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

Answer 1

Steinberg Corporation
Debt obligation ($m)	970,000
In case of expansion
EBIT ($m)	3,400,000
Equity holders will get	2,430,000
Mkt. value of equity	1,741,071.43
Equity value	1,741,071.43
Steinberg’s debtholders will receive $970,000 regardless of whether there is a recession or a continuation of the expansion.
The market value of Steinberg’s debt	866,071.43
In case of recession
EBIT ($m)	1,800,000
Equity holders will get	830,000
Dietrich Corporation
Debt obligation ($m)	1,900,000
EBIT ($m)	3,400,000
Equity holders will get	1,500,000
Mkt. value of equity	910,714.29
Equity value	910,714.29
Dietrich’s debtholders will receive $970,000 regardless of whether there is a recession or a continuation of the expansion.
The market value of Dietrich’s debt	1,696,428.57
In case of recession
EBIT ($m)	1,800,000
Equity holders will get	-100,000

Steinberg Corporation
Debt obligation ($m)	970000
In case of expansion
EBIT ($m)	3400000
Equity holders will get	=C73-C71
Mkt. value of equity	=((0.7)*(C75)+(0.3)*(C84))/1.12
Equity value	=C76
Steinberg’s debtholders will receive $970,000 regardless of whether there is a recession or a continuation of the expansion.
The market value of Steinberg’s debt	=((0.7)*(C71)+(0.3)*(C71))/1.12
In case of recession
EBIT ($m)	1800000
Equity holders will get	=C82-C71
Dietrich Corporation
Debt obligation ($m)	1900000
EBIT ($m)	3400000
Equity holders will get	=C89-C87
Mkt. value of equity	=((0.7)*(C91)+(0.3)*(C100))/1.12
Equity value	=C92
Dietrich’s debtholders will receive $970,000 regardless of whether there is a recession or a continuation of the expansion.
The market value of Dietrich’s debt	=((0.7)*(C87)+(0.3)*(C87))/1.12
In case of recession
EBIT ($m)	1800000
Equity holders will get	=C98-C87