4 the covariance is 008 040504 and the variance

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Unformatted text preview: Maturity of debt σ of firm value Lube & Auto $100 MM $80 MM 10 years 40% Equities II: R. J. Hawkins Gianni Cosmetics $150 MM $ 50 MM 10 years 50% Econ 136: Financial Economics 13/ 16 The Contingent-Claim Pricing Paradigm Implications for decision making: the conflict between bondholders and stockholders Merger of Lube & Auto and Gianni Cosmetics (Damodaran, 2012) The 10-year Treasury bond rate is 10.%. The correlation of the firm’s cash flows is 0.4: the covariance is 0.08 = (0.4)(0.5)(0.4), and the variance of the merged firm 2 2 2 2 2 σmerged = wLA σLA + wGC σGC + 2wLA wGC σLA,GC = (0.4)2 (0.4)2 + (0.6)2 (0.5)2 + 2(0.4)(0.6)(0.08) = 0.154 The capital structure on a sand-alone and merged basis: Value Firm Equity Debt Lube & Auto $100.00 MM $75.94 MM $24.06 MM Gianni Cosmetics $150.00 MM $134.48 MM $15.52 MM Equities II: R. J. Hawkins Combined $250.00 MM $207.58 MM $42.42 MM Econ 136: Financial Economics 14/ 16 The Contingent-Claim Pricing Paradigm Implications for dec...
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