Steinberg Corporation and Dietrich Corporation are identical firms except that Dietrich is more levered. Both companies will remain in business for one more year. The companies economists agree that the probability of the continuation of the current expansion is 60% for the next year, and the probability of a recession is 40%. If the expansion continues, each firm will generate EBIT of $2.4 million. If recession occurs, each firm will generate EBIT of $900,000. Steinbergs debt obligation requires the firm to pay $800,000 at the end of the year. Dietrichs debt obligation requires the firm to pay $1.1 million at the end of the year. Neither firms pay taxes. Assume a discount rate of 12%.

What is the value today of Steinbergs debt (approximate)?

$1600,000

$910,714.28

$714,285.71

$800,000

What is the value today of Steinbergs equity (approximate)?

$100,000

892,857.14

$1600,000

$696,428.57

What is the value today of Dietrichs debt (approximate)?

$1100,000

$714,285.71

$910,714.28

$900,000

What is the value today of Dietrichs equity (approximate)?

$696,428.57

$1300,000

$0 (zero)

$892,857.14

Steinbergs CEO recently stated that Steinbergs value should be higher than Dietrichs because the firm has less debt and therefore less bankruptcy risk. Do you agree or disagree with this statement?

Strongly agree

Neutral

Strongly disagree

Agree

Disagree

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