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The Chocolate Ice Cream Company and the Vanilla Ice Cream Company have agreed to merge and...

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

$

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