Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $275,000 before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value of $230,000 and costs 8 percent per year. Levered has 18,000 shares outstanding, currently worth $60 per share. Unlevered has no debt and 24,000 shares outstanding, currently worth $62 per share. Neither firm pays taxes. Is Levered’s stock a better buy than Unlevered’s stock?
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