Homemade Leverage the Veblen Company and the Knight Company are identical in ever respect except that Veblen 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

a. An investor who can borrow 6 percent per year wishes to purchase 5 percent of Knight's equity can he increase his dollar return by purchasing 5 percent of Veblen's equity if he borrows so that the initial net costs of the strategies are the same?

b. Given the two investment strategies in (a), which will investors choose? When will this process cease?

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Knight Veblen Projected operating income S300,000 S300,000 Year-end interest on debt Market value of stock S 60,000 S2,400,000 S1,714,000 Market value of debt S1,000,000