U and L are two firms with the same EBIT of $100,000. They are identical in every respect except firm L has a debt of $750,000 at 6% rate of interest. The cost of equity of firm U is 8% and that of firm L is 10%. Assume that arbitrage principle will be applied in this setting and it is possible to make an arbitrage profit (surplus). Also, all earnings streams are perpetuities, taxes are ignored and both firms distribute all earnings available to common stockholders. Assume that an investor has 20% of shares (equity) of the firm L and MM assumptions hold. That is, you will be able to borrow or lend at the same rate as the firms can (6%). How much would the arbitrage profit (surplus) be for that investor who owns 20% of equity of the firm L and plans to create that arbitrage by switching to firm U? (Do not use the $ sign in your answer. If your answer is $12,345.67, then enter 12345.67) Numeric Response
U and L are two firms with the same EBIT of $100,000. They are identical in every respect except firm L has a debt of $750,000 at 6% rate of interest. The cost of equity of firm U is 8% and that of firm L is 10%. Assume that arbitrage principle will be applied in this setting and it is possible to make an arbitrage profit (surplus). Also, all earnings streams are perpetuities, taxes are ignored and both firms distribute all earnings available to common stockholders. Assume that an investor has 20% of shares (equity) of the firm L and MM assumptions hold. That is, you will be able to borrow or lend at the same rate as the firms can (6%). How much would the arbitrage profit (surplus) be for that investor who owns 20% of equity of the firm L and plans to create that arbitrage by switching to firm U? (Do not use the $ sign in your answer. If your answer is $12,345.67, then enter 12345.67) Numeric Response
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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Transcribed Image Text:U and L are two firms with the same EBIT of $100,000. They are identical in every respect except firm L has a debt of
$750,000 at 6% rate of interest. The cost of equity of firm U is 8% and that of firm L is 10%. Assume that arbitrage
principle will be applied in this setting and it is possible to make an arbitrage profit (surplus). Also, all earnings streams
are perpetuities, taxes are ignored and both firms distribute all earnings available to common stockholders.
Assume that an investor has 20% of shares (equity) of the firm L and MM assumptions hold. That is, you will be able to
borrow or lend at the same rate as the firms can (6%). How much would the arbitrage profit (surplus) be for that investor
who owns 20% of equity of the firm L and plans to create that arbitrage by switching to firm U? (Do not use the $ sign in
your answer. If your answer is $12,345.67, then enter 12345.67)
Numeric Response
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