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 $3.4 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.8 million. Steinberg's debt obligation requires the firm to pay $970,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.9 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 12 percent. a- 1. a- 2. What are the current market values of Steinberg's equity and debt? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole dollar, e.g., 1,234,567.) What are the current market values of Dietrich's equity and debt? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole dollar, e.g., 1,234,567.) Steinberg's CEO recently stated that Steinberg's value should be higher than Dietrich's since the b. 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 $3.4 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $1.8 million. Steinberg's debt obligation requires the firm to pay $970,000 at the end of the year. Dietrich's debt obligation requires the firm to pay $1.9 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 12 percent. a- 1. a- 2. What are the current market values of Steinberg's equity and debt? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole dollar, e.g., 1,234,567.) What are the current market values of Dietrich's equity and debt? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole dollar, e.g., 1,234,567.) Steinberg's CEO recently stated that Steinberg's value should be higher than Dietrich's since the b. firm has less debt, and, therefore, less bankruptcy risk. Do you agree or disagree with this statement?
Chapter9: Capital Budgeting And Cash Flow Analysis
Section: Chapter Questions
Problem 20P
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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 $3.4 million. If a
recession occurs, each firm will generate earnings
before interest and taxes (EBIT) of $1.8 million.
Steinberg's debt obligation requires the firm to pay
$970,000 at the end of the year. Dietrich's debt
obligation requires the firm to pay $1.9 million at the
end of the year. Neither firm pays taxes. Assume a
discount rate of 12 percent.
a-
1.
a-
№
2.
b.
What are the current market values of Steinberg's
equity and debt? (Do not round intermediate
calculations and enter your answers in dollars,
not millions of dollars, rounded to the nearest
whole dollar, e.g., 1,234,567.)
What are the current market values of Dietrich's
equity and debt? (Do not round intermediate
calculations and enter your answers in dollars,
not millions of dollars, rounded to the nearest
whole dollar, e.g., 1,234,567.)
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?
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