Question

The Chocolate Ice Cream Company and the Vanilla Ice Cream Company have agreed to merge and form Fudge Swirl Consolidated. Both companies are exactly alike except that they are located in different towns. The end-of-period value of each firm is determined by the weather, as shown below. There will be no synergy to the merger.

State	Probability		Value
Rainy	.1		$	320,000
Warm	.4			500,000
Hot	.5			980,000

The weather conditions in each town are independent of those in the other. Furthermore, each company has an outstanding debt claim of $500,000. Assume that no premiums are paid in the merger.

a. What are the possible values of the combined company?

Possible states	Joint Value
Rain-Rain	$
Rain-Warm
Rain-Hot
Warm-Warm
Warm-Hot
Hot-Hot

b. What are the possible values of end-of-period debt and stock after the merger?

	Debt Value		Stock Value
Rain-Rain	$		$
Rain-Warm
Rain-Hot
Warm-Warm
Warm-Hot
Hot-Hot

c. How much do stockholders and bondholders each gain or lose if the merger is undertaken?

Bondholder gain/loss	$
Stockholder gain/loss	$

Answer 1