Company A and Company B will each company produce for one period and then cease to exist. Company As operations will generate cash flow of $900 if the economy is in an expansion and

$300 if the economy is in a recession. Company Bs operations will generate cash flow of $180 if the economy is an expansion and $1,020 if the economy is in a recession. An expansion and a recession are equally likely. Company A has debt with a face value of $360 to be repaid at the end of the period. Company B also has debt with a face value of $360 to be repaid at the end of the period. Assume no discounting, no taxes, and no financial distress costs.

a) What is the current market value of Company As equity? Company As debt? Company Bs equity? Company Bs debt?

b) Now, suppose that Company A announces that it is acquiring Company B and merging it into its own operations. The merger will not change the cash flows that either Company As or Bs operations will generate. That is, the combined company will generate the sum of Company As and Bs standalone cash flows. Company A will pay the market price of Company Bs equity that you calculated in part (a) to acquire Company B. Company A will also assume Company Bs debt. Immediately after the announcement, but before the transaction actually takes place, what will be the market value of Company As equity? Company As debt? Company Bs debt?

c) Finally, suppose that Company A announces that it acquiring Company B for the same price as in part (b), but instead of combining the two companies, as in part (b), Company A will maintain Company B as a separate wholly-owned subsidiary. Company A will not be responsible for its subsidiarys (i.e., Company Bs) debt, and the subsidiary would not responsible for Company As debt. The subsidiary would pay any cash remaining after repaying its creditor at the end of the period to Company A as a divided, which Company A could then use to repay its own debt if its own cash flow is insufficient. Immediately after the announcement, but before the transaction actually takes place, what will be the market value of Company As equity? Company As debt? Company Bs debt?