2. Illinois Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 10 percent, payable annually. The one-year interest rate is 10 percent. Next year, there is a 30 percent probability that interest rates will increase to 12 percent, and there is a 70 percent probability that they will fall to 6 percent.

Required:

(a)

What will the market value of these bonds be if they are noncallable? (Do not include the dollar sign ($). Round your answer to 2 decimal places. (e.g., 32.16))

  Market value

$ 

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 85 percent for the next year, and the probability of a recession is 15 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $2.41 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $915,000. Steinberg’s debt obligation requires the firm to pay $805,000 at the end of the year. Dietrich’s debt obligation requires the firm to pay $1.18 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 13 percent.

Requirement 1:

What is the value today of Steinberg’s debt and equity? What about that for Dietrich’s? (Do not include the dollar signs ($). Enter your answers in dollars, not millions of dollars. (e.g., 1,234,567))

Debt

Equity

  Steinberg

$ 

Zoso is a rental car company that is trying to determine whether to add 30 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $148,000 per year in earnings before taxes and depreciation for five years. The company is entirely financed by equity and has a 32 percent tax rate. The required return on the company’s unlevered equity is 13.9 percent, and the new fleet will not change the risk of the company.

Requirement 1:

What is the maximum price that the company should be willing to pay for the new fleet of cars if it remains an all-equity company? (Do not include the dollar sign ($). Round your answer to 2 decimal places. (e.g., 32.16))

   Maximum price

$ 

Seger, Inc., is an unlevered firm with expected annual earnings before taxes of $32 million in perpetuity. The current required return on the firm’s equity is 20 percent, and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.6 million shares of common stock outstanding and is subject to a corporate tax rate of 40 percent. The firm is planning a recapitalization under which it will issue $35 million of perpetual 10 percent debt and use the proceeds to buy back shares.

Requirement 1:

Calculate the value of the company before the recapitalization plan is announced. What is the value of equity before the announcement? What is the price per share? (Do not include the dollar signs ($). Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your price per share to 2 decimal places. (e.g., 32.16))

  Value of equity

$ [removed]  

  Price per share

$ [removed]  

Requirement 2:

Use the APV method to calculate the company value after the recapitalization plan is announced. What is the value of equity after the announcement? What is the price per share? (Do not include the dollar signs ($). Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your new share price to 2 decimal places. (e.g., 32.16))

  Value of equity

$ [removed]  

  New share price

$ [removed]  

Requirement 3:

How many shares will be repurchased? What is the value of equity after the repurchase has been completed? What is the price per share? (Do not include the dollar signs ($). Round your shares repurchased to the nearest whole number (e.g., 32). Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your new share price to 2 decimal places. (e.g., 32.16))

  Shares repurchased

[removed]  

  Value of equity

$ [removed]  

  New share price

$ [removed]  

Requirement 4:

Use the flow to equity method to calculate the value of the company’s equity after the recapitalization. (Do not include the dollar sign ($). Enter your answer in dollars, not millions of dollars. (e.g., 1,234,567))

  Value of equity

$ [removed]