d) What will your price-earnings ratio be after the merger( if you pay no premium)? How does this compare to your P / E ratio before the merger? How does this compare to TargetCo’ s premerger P / E ratio?
Problem 16-8 on Managerial Decision Based on Chapter 16 Financial Distress, Managerial Incentives, and Information
As in Problem 1, Gladstone Corporation is about to launch a new product. Depending on the success of the new product, Gladstone may have one of four values next year: $ 150 million, $ 135 million, $ 95 million, or $ 80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5 % and that, in the event of default, 25 % of the value of Gladstone’ s assets will be lost to bankruptcy costs.( Ignore all other market imperfections, such as taxes.) a) What is the initial value of Gladstone’ s equity without leverage?
Now suppose Gladstone has zero-coupon debt with a $ 100 million face value due next year.
b) What is the initial value of Gladstone’ s debt? c) What is the yield-to-maturity of the debt? What is its expected return?
d) What is the initial value of Gladstone’ s equity? What is Gladstone’ s total value with leverage?
Suppose Gladstone has 10 million shares outstanding and no debt at the start of the year.
e) If Gladstone does not issue debt, what is its share price?
f) If Gladstone issues debt of $ 100 million due next year and uses the proceeds to repurchase shares, what will its share price be? Why does your answer differ from that in part e)?
Problem 16-9 on Financial Distress Based on Chapter 16 Financial Distress, Managerial Incentives, and Information
Kohwe Corporation plans to issue equity to raise $ 50 million to finance a new investment. After making the investment, Kohwe expects to earn free cash flows of $ 10 million each year. Kohwe currently has 5 million shares outstanding, and it has no other assets or opportunities.