Problem 22-24 Mergers and Equity as an Option Sunburn Sunscreen has a zero coupo

Question

Problem 22-24 Mergers and Equity as an Option Sunburn Sunscreen has a zero coupon bond issue outstanding with a $12,000 face value that matures in one year. The current market value of the firm’s assets is $13,800. The standard deviation of the return on the firm’s assets is 30 percent per year, and the annual risk-free rate is 6 percent per year, compounded continuously. Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $42,000 that matures in one year. The current market value of the firm’s assets is $45,600. The standard deviation of the return on the firm’s assets is 36 percent per year. Suppose Sunburn Sunscreen and Frostbite Thermalwear have decided to merge. Because the two companies have seasonal sales, the combined firm’s return on assets will have a standard deviation of 19 percent per year.

a-1. What is the combined value of equity in the two existing companies? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Equity $

a-2. What is the combined value of debt in the two existing companies? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Debt $

b-1. What is the value of the new firm’s equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Equity $

b-2. What is the value of the new firm’s debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Debt $

c-1. What was the gain or loss for shareholders? (Loss amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Gain / Loss $

c-2. What was the gain or loss for bondholders? (Loss amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Gain / Loss $

Explanation / Answer

Ans) sun burn sun screen Particulars Amount($) Debt (1) 12000 Market value of firms assets (2) 13800 Vale of Equity (2-1) 1800 standard devation on firm assets 30% Risk free rate 6% Frostbite Thermalwear Particulars Amount ($) Zero cupon debt 42000 Current value of firms assets 45600 Equity 3600 standard deviation 36% Combined standard deviation 19% a-1 Combined Value of Equity sun burn sun screen ($) Frostbite Thermalwear($) Combined value of equity($) Equity 1800 3600 5400 Combined value of equity in the two existing companies is 5400$ a-2 Combined Value of Equity sun burn sun screen($) Frostbite Thermalwear($) Combined value of equity($) Debt 12000 42000 54000 b-1 Particulars Amount ($) Value of the new firms Equity 5400 b-2 Particulars Amount ($) Value of new firms Debt 54000 Value of new firms Assets 59400 Note :- Since no synergy exist Value of new equity and debt and combined Equity and debt of both companies are same c-1 Gain or loss for shareholders Combined ($) sun burn sun screen ($) Frostbite Thermalwear ($) Combined Value of New Equity(Assume 1:1) 5400 2700 2700 Value of Existing Equity 5400 1800 3600 Gain /Loss 0 900 -900 C-2 Gain or loss for Bond holders Combined ($) sun burn sun screen ($) Frostbite Thermalwear ($) Combined Value of New Debt (Assume 1:1) 54000 27000 27000 Value of Existing Debt 54000 12000 42000 Gain or (loss )for Bond holders 0 15000 -15000 Note Since information given about swaap ratio assume that 1:1 Note Since no synergy exist in merger Total gain or loss is Nil

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