Question

The Day Company and the Knight Company are identical in every respect except that Day is not levered. Financial information for the two firms appears in the following table. All earnings streams are perpetuities, and neither firm pays taxes. Both firms distribute all earnings available to common stockholders immediately. Day Knight Projected operating income $ 1,200,000 $ 1,200,000 Year-end interest on debt − $ 100,000 Market value of stock $ 4,500,000 $ 2,750,000 Market value of debt − $ 2,000,000 a-1. What will the annual cash flow be to an investor who purchases 5 percent of Knight's equity? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g ., 32.) a-2. What is the annual net cash flow to the investor if 5 percent of Day's equity is purchased instead? Assume that borrowing occurs so that the net initial investment in each company is equal. The interest rate on debt is 5 percent per year. (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Answer 1