Wintech Corp. has a zero coupon bond issue outstanding with a $15,000 face value that matures in one year. The current market value of the firms assets is $15,800. The standard deviation of the return on the firms assets is 38 percent per year, and the annual risk-free rate is 5 percent per year, compounded continuously.

Market value of Equity= $3,110.88

Market value of Debt= $12,689.12

Highdyne Corp. has a zero coupon bond issue outstanding with a face value of $25,000 that matures in one year. The current market value of the firms assets is $27,200. The standard deviation of the return on the firms assets is 53 percent per year, and the risk-free rate is 5 percent per year, compounded continuously.

Market value of Equity= $7,201.90

Market value of Debt= $19,998.10

Managers at Wintech and Highdyne are considering a merger to diversify the firms. Because the two companies have seasonal sales, the combined firms return on assets would have a standard deviation of 29 percent per year. No other synergies from the business combination have been identified.

a. What is the aggregate value of equity in the two existing companies? The aggregate value of debt?

b. What would be the value of the new firms equity? The value of debt?

c. What would be the gain or loss for shareholders? For bondholders?

d. What happens to shareholder value here? Can you explain why this would occur?

e. Under these circumstances, what course of action by managers would be consistent with their fiduciary duty to the shareholders?