Problem #1: Consider a firm that has a total firm value of $500 million and a Debt-to-Value ratio of 20%. The firm is in a 25% tax bracket. There are 100,000 shares outstanding. Management announces that the company wants to issue additional debt and buy back some stock so that the Debt-to Value ratio will increase to 25%. What will be the new share price after the announcement? Problem #2: Consider a conglomerate, non-synergistic, merger between two firms ABC and XYZ. In a purely conglomerate merger, the post-merger firm value is the sum of the two pre-merger values because there is no synergy. ABC has a total current market value of $6 billion. ABCs capital structure is composed of common stock and a 5-year zero-coupon debt with a face value of $2.5 billion, and its Black-Scholes volatility () is 35% based on the firm as a whole. XYZ has a total current market value of $5 billion and a 5-year zero-coupon debt with face value of $ 3 billion and Black-Scholes () volatility of 45%. The risk-free rate is 5%.

(a) What are the current market values of debt and equity in ABC and XYZ (b) What are the values of debt and equity after the merger if the correlation between the cashflows of the two firms is 0.2?

Problem #3: You have been hired to analyze a new 20-year Callable Convertible Bond. The bond pays a 6% coupon annually, and is selling at par. The conversion price is $150 and the stock is currently selling at $35. The bond is callable at $1,150, but analysts believe that the bond will not be called unless the conversion value reaches $1,250. The YTM of a 20-year non-callable, non-convertible bond is 8.5%.

(a) What would be the price of the bond if it did not have the call and conversion features? (b) Would the bond sell at a premium or a discount if it was convertible but not callable? (c) Would the bond sell at a premium or a discount if it was callable but not convertible?