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Question 7 : Attention Industries has two divisions. Division 1 makes cleaning products and the net worth of this division ( present value of cash
Question : Attention Industries has two divisions. Division makes cleaning products and the net worth of this division present value of cash flows is $ Division makes a chemical product. The net worth of division is $ absent any potential liability. There is a chance that disvision could have $ liability for pollution damage. The potential victims have no contractual relationship with the firm. The probability of such a loss is s where s is the amount the firm spends on safety. The firm must choose the level of s Note that the derivative of as with respect to s is equal to as
i First, calculate the total value of the firm, including both divisions at the same time, as an equation of s Second, take derivative with respect to s to find the s that maximizes the total value. Third, plug in the value of s you found into total value equation to find the maximum total value.
ii Division is riskless and has a standalone value of $ Since all the risk comes from division we must consider the chosen level of safety s of this unit as a standalone entity. First, calculate the standalone value of division as an equation of s Second, take derivative with respect to s to find the s that maximizes the standalone value of division Third, plug in the value of s you found into the equation of standalone value of division to find the maximum standalone value of division Hint: the value of division is $ if no liability arises. However, if a loss of $ occurs it cannot pay more than the original $ standalone value due to limited liability. iii What is the maximum value of the firm if we treat division as a separate entity? Note that we are splitting the two divisions assuming that separated division as a standalone firm is protected by limited liability. Hint: Add your answer to part ii to the net worth of division The probability of such a loss is where s is the amount the firm spends on safety. The firm must choose the level of s Note that the derivative of with respect to s is equal to
i First, calculate the total value of the firm, including both divisions at the same time, as an equation of s Second, take derivative with respect to to find the that maximizes the total value. Third, plug in the value of s you found into total value equation to find the maximum total value.
ii Division is riskless and has a standalone value of $ Since all the risk comes from division we must consider the chosen level of safety of this unit as a standalone entity.
First, calculate the standalone value of division as an equation of s Second, take derivative with respect to to find the that maximizes the standalone value of division
Third, plug in the value of s you found into the equation of standalone value of division to find the maximum standalone value of division Hint: the value of division is $ if no liability arises. However, if a loss of $ occurs it cannot pay more than the original $ standalone value due to limited liability.
iii What is the maximum value of the firm if we treat division as a separate entity? Note that we are splitting the two divisions assuming that separated division as a standalone firm is protected by limited liability. Hint: Add your answer to part ii to the net worth of division
iv Is there a gain from splitting the firm up Calculate the numerical value of gainlossHint: It is the difference between the maximum total value without split up that you found in i and the maximum total value with split up that you found in iii
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