For this problem and the next, assume the following: (a) We are dealing with a world where

Question:

For this problem and the next, assume the following:
(a) We are dealing with a world where there are no taxes.
(b) The changes in the parameters affecting value are unanticipated; therefore redistribution effects are possible.
(c) Firms A and B initially have the following parameters:
(A = (B = .2 ............. Instantaneous standard deviation
TA = TB = 4 years......... of debt
VA = VB = $2,000 ...... Value of the firm, V = B + S
Rf = .06 ................... Risk free rate
DA = DB = $1,000 ....... of debt
The correlation between the cash flows of firms A and B is .6. If they merge, the resultant firm will be worth $4,000 = VA + VB, but its new instantaneous variance will be

What will be the market value of debt and equity in the merged firm? If there were no other merger effects, would shareholders agree to the merger?

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