Question
In: Finance
Assume that two firms, U and L, are identical in all respects except for one: Firm...
Assume that two firms, U and L, are identical in all respects except for one: Firm U is debt-free, whereas Firm L has a capital structure that is 50% debt and 50% equity by market value. Further suppose that the assumptions of M&M's "irrelevance" Proposition I hold (no taxes or transaction costs, no bankruptcy costs, etc.) and that each firm will have income before interest and taxes of $800,000.
If the required return on assets, rA, for these firms is 12.5% and if the risk-free debt yields 5%. calculate the following values for both Firm U and Firm L: (1) total firm value, (2) market value of debt and equity, and (3) required return on equity.
Now, recompute these values while assuming that the market mistakenly assigns Firm L's equity a required return of 15%, and describe the arbitrage operation that will force Firm L's valuation back into equilibrium.
Solutions
jeff jeffy answered 2 years agoRelated Solutions
Consider two firms L and U which are identical in all aspects except for capital structure....
Consider two firms L and U which are identical in all aspects
except for capital structure. The EBIT and cost of capital for each
firm is Sh. 900,000 and 10% respectively. U is an all-equity
financed firm while L has 7.5% of Sh.4, 000,000 debt.
a. Estimate the value of levered firm (L) and Unlevered firm (U)
using Net Income (NI) approach;
b. Establish whether there is an arbitrage opportunity
c. Estimate the arbitrage profits if any by considering an...
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15.4 Two systems are identical in all respects except that in
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Calculate the difference between their molar entropies.
Physical Chemistry (4th edition), Laidler, Meise, Sanctuary
ABC and XYZ are identical firms in all respects except for their capital structure. ABC is...
ABC and XYZ are identical firms in all respects except for their
capital structure. ABC is all equity financed with $800,000 in
stock. XYZ uses both stock and perpetual debt; its stock is worth
$400,000 and the interest rate on its debt is 10%. Both firms
expect EBIT to be $95,000 and all income will be distributed as
dividends. Ignore taxes.
a. Richard owns $30,000 worth of XYZ stock. What rate of return
is he expecting?
b. Show how Richard...
ABC and XYZ are identical firms in all respects except for their capital structures. ABC is...
ABC and XYZ are identical firms in all respects except for their
capital structures. ABC is all-equity financed with $530,000 in
stock. XYZ has the same total value but uses both stock and
perpetual debt; its stock is worth $310,000 and the interest rate
on its debt is 7.9 percent. Both firms expect EBIT to be $62,222.
Ignore taxes. The cost of equity for ABC is ________ percent and
for XYZ it is ________ percent. Select one: A. 12.09; 12.48...
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure....
ABC Co. and XYZ Co. are identical firms in all respects except
for their capital structure. ABC is all equity financed with
$750,000 in stock. XYZ uses both stock and perpetual debt; its
stock is worth $375,000 and the interest rate on its debt is 10
percent. Both firms expect EBIT to be $73,000. Ignore taxes.
A) You own $56,250 worth of XYZ’s stock. What rate of return are
you expecting?
B) Calculate the cash flows and rate of return...
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure....
ABC Co. and XYZ Co. are identical firms in all respects except
for their capital structure. ABC is all equity financed with
$800,000 in stock. XYZ uses both stock and perpetual debt; its
stock is worth $400,000 and the interest rate on its debt is 5.2
percent. Both firms expect EBIT to be $79,000. Ignore taxes.
a.
Richard owns $60,000 worth of XYZ’s stock. What rate of return
is he expecting? (Do not round intermediate calculations
and enter your answer...
ABC co. And XYZ co. are identical firms in all respects except for their capital structures....
ABC
co. And XYZ co. are identical firms in all respects except for
their capital structures. ABC is all-equity financed with $650,000
in stock. XYZ uses both stock and perpetual debt, it’s stock is
worth $325,000 and the interest rate on its debt is 6.5 percent.
Both firms expect EBIT to be $71,000. Ignore taxes
A.) Richards owns $39,000 worth of XYZ’s stock. What rate of
return is he expecting?
B.) Suppose Richard invests in ABC co. and uses homemade...
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure....
ABC Co. and XYZ Co. are identical firms in all respects except
for their capital structure. ABC is all equity financed with
$800,000 in stock. XYZ uses both stock and perpetual debt; its
stock is worth $400,000 and the interest rate on its debt is 5.2
percent. Both firms expect EBIT to be $79,000. Ignore taxes.
a. Rico owns $60,000 worth of XYZ’s stock. What rate of return
is he expecting? (Do not round intermediate calculations and enter
your answer...
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure....
ABC Co. and XYZ Co. are identical firms in all respects except
for their capital structure. ABC is all equity financed with
$875,000 in stock. XYZ uses both stock and perpetual debt; its
stock is worth $437,500 and the interest rate on its debt is 8
percent. Both firms expect EBIT to be $91,000. Ignore taxes. NOT
EXCEL
a.
Richard owns $87,500 worth of XYZ’s stock. What rate of return
is he expecting?
b.
Suppose Richard invests in ABC...
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure....
ABC Co. and XYZ Co. are identical firms in all respects except
for their capital structure. ABC is all equity financed with
$500,000 of equity. XYZ uses both equity and perpetual debt; its
equity is worth $280,000 and the interest rate on its debt is 10
percent. Both firms expect EBIT to be $60,000. Ignore taxes (i.e.
Modigliani-Miller without taxes or other frictions).
Compute the cost of equity for ABC.
Compute the cost of equity for XYZ.
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