Firm U is an all-equity firm and has a market value of $100,000 and EBIT of $300,000. Firm L has identical EBIT, but it uses 40% debt in its capital structure. Firm L pays a total annual interest of $3000 on its debt. Both firms satisfy the MM assumptions. Taxes are absent. 1) Ryan is the holder of $9,000 worth of L's stock. What rate of return can he expect, assuming a dividend pay-out of 100%? 2) Using homemade leverage, show how Ryan could generate identical cash flows and rate of return by investing in Firm U.
Firm U is an all-equity firm and has a market value of $100,000 and EBIT of $300,000. Firm L has identical EBIT, but it uses 40% debt in its capital structure. Firm L pays a total annual interest of $3000 on its debt. Both firms satisfy the MM assumptions. Taxes are absent. 1) Ryan is the holder of $9,000 worth of L's stock. What rate of return can he expect, assuming a dividend pay-out of 100%? 2) Using homemade leverage, show how Ryan could generate identical cash flows and rate of return by investing in Firm U.
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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![Firm U is an all-equity firm and has a market value
of $100,000 and EBIT of $300,000. Firm L has
identical EBIT, but it uses 40% debt in its capital
structure. Firm L pays a total annual interest of
$3000 on its debt. Both firms satisfy the MM
assumptions. Taxes are absent.
1) Ryan is the holder of $9,000 worth of L's stock.
What rate of return can he expect, assuming a
dividend pay-out of 100%?
2) Using homemade leverage, show how Ryan could
generate identical cash flows and rate of return by
investing in Firm U.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fb5046534-220a-40e4-bc2f-3c2666c68b9b%2F98d1d30e-838b-41e6-a277-634d4f2df906%2F99actkk_processed.png&w=3840&q=75)
Transcribed Image Text:Firm U is an all-equity firm and has a market value
of $100,000 and EBIT of $300,000. Firm L has
identical EBIT, but it uses 40% debt in its capital
structure. Firm L pays a total annual interest of
$3000 on its debt. Both firms satisfy the MM
assumptions. Taxes are absent.
1) Ryan is the holder of $9,000 worth of L's stock.
What rate of return can he expect, assuming a
dividend pay-out of 100%?
2) Using homemade leverage, show how Ryan could
generate identical cash flows and rate of return by
investing in Firm U.
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