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 .