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?