Firm a Does Well in a Boom Economy

question 42

Multiple Choice

Firm A does well in a boom economy.Firm B does well in a bust economy.The probability of a boom is 50%.The end of period values of the two firms depend on the economy as shown below: Both firms have debt outstanding with a face value of $1,000.In order to diversify,the two firms have proposed a merger.The NPV of the merger is zero.Which of the following statements is correct?

• A) The stockholders are indifferent to merger since the NPV is zero.
• B) The bondholders are indifferent to merger since the NPV is zero.
• C) The bondholders stand to gain because the risk of the combined firm is less.
• D) The stockholders stand to gain because the probability of bankruptcy becomes zero after the merger.

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Definitions:

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