You work in the corporate finance office of AAPL Corp., which is thinking about ac- quiring SPOT Corp. to enhance their music business. Prior to the acquisition, the market capitalization of AAPL is $355 billion. Given the uncertain nature of tech firms, the earnings (assets) of AAPL and SPOT are very volatile. Their joint assets have an annual standard deviation of 30%.

SPOT is worth $115 billion. AAPL plans to finance the deal by issuing a 5-year zero- coupon bond. AAPL has no debt prior to the acquisition.

For the pricing, use the binomial model with annual periods. The risk-free rate is 2% per year.

(a) What is the binomial tree for the asset value after the acquisition?

(b) How much debt do they have to issue? What is the face value of the debt (K) to finance the deal? Hint: Use Solver to find K.

(c) What is the yield-to-maturity on the debt?

(d) How large is the credit risk component of the yield-to-maturity?

(e) What is the leverage and debt-equity ratio after the acquisition?