Suppose firm A and firm B are planning on merging. There are no costs or synergy benefits from the merger. Before the merger firm A has an issue of bonds outstanding. These bonds entitle the holder to a payment of $80 million when the bonds mature next year. Firm B has no debt and the risk free interest rate is 0. (hint- that means you do not need to discount any cash flows)

With probability .5 there will be a boom in the economy next year and with probability .5 there will be a recession. The value of firm As assets and firm Bs assets in a recession and a boom are as follows:

	boom (probability .5)	recession (probability .5)
Firm A asset value	$160 million	$50 million
Firm B asset value	$100 million	$30 million

[10 points] Using the analysis from class on the coinsurance effects of merging, what will be the change in the value of the bonds if the firms merge?

[5 points] Briefly indicate two ways that the firm could solve the problem of the coinsurance effects of merging?