Expansion Recession Steinberg's debt $ 900,000

Probilitty 80% 20% Dietrich's debt $ 1,200,000

EBIT $ 2,700,000 $ 1,100,000 Discount rate 13%

a)
Steinberg
Expansion Recession
Stockholders receive $ 1,800,000 $ 200,000
Steinberg's equity $ 1,309,734.51

Steinberg's bondholders will receive $900,000 whether there is a recession or a

continuation of the expansion. So, the market value of Steinberg's debt is:
$ 796,460.18

Dietrich
Expansion Recession
Stockholders receive $ 1,500,000 0 If there is a recession, its stockholders will receive nothing
Steinberg's equity ` bondholders have a more senior claim on all $1,500,000 of t

Dietrich's bondholders will receive $1,200,000 if the expansion continues and

$1,100,000 if there is a recession. So, the market value of Dietrich's debt is
$ 1,044,247.79

b)
Value of Steinberg $ 2,106,194.69
Value òf Dietrich $ 2,544,247.79

I disagree with the CEO's statement. The risk of bankruptcy per se does not affect a
firm's value. It is the actual costs of bankruptcy that decrease the value of a firm.
ders will receive nothing since the firm's
im on all $1,500,000 of the firm's earnings
a)
If recession happens, the total cash flow is $76 million. As bondholders have the first right on all cash flows, the payo
b)
Promise return on debt= (Promised amount/current market value) -1
Promise amount $ 110,000,000
Current market
value $83,000,000
Promise return on
debt 32.53%
c)
In case boom happens, the realized return=promised return=32.53%
In case recession happens, the realized return=(realized payoff/ current market value)-1
Realized payoff 76,000,000
Current market value 83,000,000
The realized return -8.43%
The expected return= Probability of boom* Realized return + Probability of recession * Realized return

The expected return 16.14%

 Probability of boom
Probability of recession
total cash flow in boom
total cash flow in recession
Debt
outstanding debt
60%
40%
$ 185,000,000
$ 76,000,000
$ 110,000,000
$ 83,000,000

st right on all cash flows, the payoff for bondholders in the case of a recession is entire $76 million

ecession * Realized return