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Suppose firm A and firm B are planning on merging. There are no costs or benefits from the merger. Before the merger firm A has
Suppose firm A and firm B are planning on merging. There are no costs or benefits from the merger. Before the merger firm A has an issue of bonds outstanding and Firm B has an issue of bonds outstanding. The Firm A bonds entitle the holder to a payment of $20 million when the bonds mature next year, and the Firm B bonds entitle the holder to a payment of $25 million when the bonds mature next year. The risk free interest rate is 0. With probability 1/3 there will be a "boom" in the economy next year, with probability 1/3 there will be a "normal" economy next year, and with probability 1/3 there will be a "recession" next year. The value of firm A's assets and firm B's assets in "boom", "normal", and "recession" years are as follows. (a) What will be the change in the total value of all outstanding bonds if the firms merge? (b) What will be the change in the total value of all outstanding equity if the firms merge
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