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In: Finance

Please do it in excel showing fromulas Steinberg Corporation and Dietrich Corporation are identical firms except...

Please do it in excel showing fromulas

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 $1,050,000. Steinberg’s debt obligation requires the firm to pay $900,000 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 14 percent.

  1. a) What are the current market values of Steinberg’s equity and debt? What about those of Dietrich?

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

Solutions

Expert Solution

Solution:- Given in Question-

The current market values of Steinberg’s equity and debt-

Steinberg Potential Payoffs-

Equity =

Equity =  14,29,824.56

Debt =

Debt = 7,89,473.68

Dietrich Potential Payoffs-

Equity =

Equity = 11,22,807.02

Debt =

Debt = 10,96,491.23

B. Steinberg’s value should be higher than Dietrich’s since the firm has less debt, and, therefore, less bankruptcy risk -

Value of Steinberg = Equity + Debt

Value of Steinberg = 14,29,824.56 + 7,89,473.78

Value of Steinberg = 22,19,298

Value of Dietrich = Equity + Debt

Value of Dietrich = 11,22,807.02 + 10,96,491.23

Value of Dietrich = 22,19,298

The Values of the Two firms are identical.

The EBIT's of two firm are identical it means that it is an example of re-distributing of wealth between bonds and stake holders.

If you have any query related to question then feel free to ask me in a comment. Thanks. Please rate.

jeff jeffy answered 2 years ago
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