Identical firms except that dietrich has more leverage

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Reference no: EM131900861

1. Steinberg Corporation and Dietrich Corporation are apparently identical firms except that Dietrich has more leverage. Both companies will remain in business for one year. The companies’ economists agree that the probability of continuation of the current expansion is 80 percent for the next year, and the probability of recession is 20 percent. If the expansion continues, each firm expects to generate earnings before interest and taxes (EBIT) of $2.7 million. If the recession occurs, each firm expects to generate EBIT of $1.1 million. Steinberg's debt obligation requires the firm to pay $900,000 at the end of the year. Dietrich’s debt obligation requires the firm pay $1.2 million at the end of the year. Neither firm pays taxes. Assume the required return on Steinberg's debt is 10 percent, and that for Dietrich is 10.5 percent. Assume Steinberg's equity cost of capital is 13 percent and Dietrich's equity cost of capital is 13.2 percent.

What is the value of Dietrich’s debt and equity?

A. Debt = $1,180,000, Equity = $1,200,000

B. None of these values are correct

C. Debt = $1,044,248, Equity = $1,061,947

D. Debt = $1,067,873, Equity = $1,060,071

2. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The standard deviation of return on the minimum-variance portfolio is _________.

12%

17%

Reference no: EM131900861

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