Firm A and B have the same capital structure. A: No debt. B: have £100m debt and pay 5% interest rate. Assume: no tax and perfect capital market. The firm lend and borrow at same risk-free rate. Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant. 1）What is the profit from arbitrage? (Answer: 25 or 0.25) 2)The after interests return from the investor’s position? (Answer: 1) 3)What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt? (Answer: 6.25 or 625
Firm A and B have the same capital structure. A: No debt. B: have £100m debt and pay 5% interest rate. Assume: no tax and perfect capital market. The firm lend and borrow at same risk-free rate. Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant. 1）What is the profit from arbitrage? (Answer: 25 or 0.25) 2)The after interests return from the investor’s position? (Answer: 1) 3)What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt? (Answer: 6.25 or 625
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
Firm A and B have the same capital structure. A: No debt. B: have £100m debt and pay 5% interest rate. Assume: no tax and perfect capital market. The firm lend and borrow at same risk-free rate.
Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant.
1）What is the profit from arbitrage? (Answer: 25 or 0.25)
2)The after interests return from the investor’s position? (Answer: 1)
3)What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt? (Answer: 6.25 or 625)
How to calculate this result?
Transcribed Image Text:A
В
Value of Firm
200
250
Debt
100
Equity
200
150
Earnings before interest
20
20
Interest payment
5
Interest rate
Not Applicable
5%
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