clacher plc and Holmes plc are two firms with identical prospects regarding their future cashflows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. Holmes plc announces that it is going to issue additional perpetual debt, with promised interest payments of £1,200. The funds generated will be used to make a one-off payment to equity holders and there will be no other impact on expected cash flows. Calculate the value of Holmes’ equity after the transaction described above has been undertaken.
clacher plc and Holmes plc are two firms with identical prospects regarding their future cashflows. The
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