Question 1 (10 points) Somber Farms is a chain of treatment centers for depressi

Question

Question 1 (10 points) Somber Farms is a chain of treatment centers for depression, and Hipper Image is a retail chain for expensive novelty items. Somber Farms has a $155M debt obligation due at the end of the period; Hipper Image is debt free. (The firms operate in a one-period economy with three states of the world, no taxes, risk neutral investors, and rf-0%). Each firm's EBIT cash flows are as follows: Firm EBIT by State of Economy ($M) Boom 0.25 Stable Growth 0.50 Recessioin 0.25 Probability Somber Farms Hipper Image 300 400 700 200 500 a. What is the value of Somber Farms' debt? Answer b. What is the value of Somber Farms' equity? Answer c. What is the value of Hipper Image's equity? Answer

Explanation / Answer

Part - A

Somber Farm Debt = $ 155 Million

Part -B

Somber Farms Equity

Firm Value (EBIT) = (0.25*0)+(0.50*300)+(0.25*700)

=0+150+175

= $ 325 Million

Firm Equity = Firm Value - Debt

=325-155

= $ 170 Million

Part -C

Hipper Image's Equity

There is no Debt on Hipper image's.

Firm Equity = (0.25*500)+(0.50*400)+(0.25*200)

=125+200+50

= $ 375 Million

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