Consider Two Firms,ABC and XYZ

question 62

Multiple Choice

Consider two firms,ABC and XYZ.Both companies will either make $5 million or lose $2 million every year with equal probability.The companies' profits are perfectly negatively correlated,so that in any year,one company makes $5 million and the other loses $2 million.The two firms decide to enter into a merger and combine operations.What are the expected after-tax profits of the combined company in any year,assuming a corporate tax rate of 35% and no tax loss carryback or carryforward,if they are run as two independent divisions?

• A)$6 million
• B)$3.25 million
• C)$6.5 million
• D)$3 million
• E)$1.95 million

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Definitions:

Market Price Per Share

This is the current price at which a single share of a company's stock can be bought or sold in the market.

Return on Equity

A measure of a corporation's profitability, calculated as net income divided by shareholder's equity.

Debt-Equity Ratio

A financial metric used to evaluate a company's leverage, by calculating the division of its total debts by the equity of its investors.

Net Income

The total earnings of a company after all expenses and taxes have been deducted from revenue.