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 70 percent for the next year and the probability of a recession is 30 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $3.2 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.6 million. Steinberg's debt obligation requires the firm to pay $950,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.7 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 12 percent. a-1. What is the value today of Steinberg's debt and equity? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234, 567.) a-2. What is the value today of Dietrich's debt and equity? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1, 234, 567.) 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 70 percent for the next year and the probability of a recession is 30 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $3.2 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.6 million. Steinberg's debt obligation requires the firm to pay $950,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.7 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 12 percent. a-1. What is the value today of Steinberg's debt and equity? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234, 567.) a-2. What is the value today of Dietrich's debt and equity? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1, 234, 567.) 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?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text: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 70 percent for the next year and the probability of a
recession is 30 percent. If the expansion continues, each firm will generate
earnings before interest and taxes (EBIT) of $3.2 million. If a recession occurs,
each firm will generate earnings before interest and taxes (EBIT) of $1.6 million.
Steinberg's debt obligation requires the firm to pay $950,000 at the end of the
year. Dietrich's debt obligation requires the firm to pay $1.7 million at the end of
the year. Neither firm pays taxes. Assume a discount rate of 12 percent. a-1.
What is the value today of Steinberg's debt and equity? (Do not round
intermediate calculations and enter your answers in dollars, not millions of
dollars, rounded to the nearest whole number, e.g., 1, 234, 567.) a-2. What is
the value today of Dietrich's debt and equity? (Do not round intermediate
calculations and enter your answers in dollars, not millions of dollars, rounded to
the nearest whole number, e.g., 1, 234, 567.) 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?
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