Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation,...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 5,000 shares of stock outstanding, currently worth $20per share. Beta Corporation uses leverage in its capital structure. The market value of Beta's debt is $25,000 and its cost of debt is 12 percent. Each firm is expected to have earnings before interest of $35,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 12 percent per year. (a) What is the value of Alpha Corporation? (b) What is the value of Beta Corporation? (c) What is the market value of Beta Corporation's equity? (d) How much will it cost to purchase 20 percent of Each firm's equity? (e) Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year? What will be the ROE for each position? (f) Construct an investment strategy in which an investor purchases 20 percent of Alpha's equity and replicates both the cost and dollar return of purchasing 20 percent of Beta's equity. (g) Is Alpha's equity more or less risky than Beta's equity? Explain. Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 5,000 shares of stock outstanding, currently worth $20per share. Beta Corporation uses leverage in its capital structure. The market value of Beta's debt is $25,000 and its cost of debt is 12 percent. Each firm is expected to have earnings before interest of $35,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 12 percent per year. (a) What is the value of Alpha Corporation? (b) What is the value of Beta Corporation? (c) What is the market value of Beta Corporation's equity? (d) How much will it cost to purchase 20 percent of Each firm's equity? (e) Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year? What will be the ROE for each position? (f) Construct an investment strategy in which an investor purchases 20 percent of Alpha's equity and replicates both the cost and dollar return of purchasing 20 percent of Beta's equity. (g) Is Alpha's equity more or less risky than Beta's equity? Explain.
Expert Answer:
Answer rating: 100% (QA)
a Since Alpha Corporation is an all equity firm its value is equal to the market value of its outstanding shares Alpha has 5000 shares of common stock outstanding each worth 20 per share Therefore the ... View the full answer
Related Book For
Fundamentals of Financial Management
ISBN: 978-0324272055
10th edition
Authors: Eugene F. Brigham, Joel F. Houston
Posted Date:
Students also viewed these finance questions
-
An annuity paying $1400 at the end of each month (except for a smaller final payment) was purchased with $225,000 that had accumulated in an RRSP. The annuity provides a semiannually compounded rate...
-
1. Use the following information to discuss some of the most likely issues to face the Venezuelan economy in light of in-class content. (a) Since 2002, Venezuela has embarked on a process of...
-
Consider a monopolist firm in a market with demand curve P= 1797-3Q. Suppose the firm has marginal cost curve MC = 4Q. What is the firm's total revenue at the profit maximizing quantity? Give your...
-
Brandon Stroud was driving a golf car made by Textron, Inc., to transport guests at Christmas party. The golf car did not have lights, but Textron did not warn against using it on public roads at...
-
Refer to the information for Pizza Vesuvio on the previous page. Assume that this information was used to construct the following formula for monthly labor cost. Total labor cost = $5,237 + ($7.40 x...
-
Explain how Bayes optimal classifier and the nave Bayes classifier work.
-
Why is it sometimes necessary to serve a subpoena for production of documents?
-
In Problem 34 in Chapter 1, when Tracy McCoy wakes up Saturday morning, she remembers that she promised the PTA she would make some cakes and/or homemade bread for its bake sale that afternoon....
-
Newton's Method: Let f be a differentiable function on an interval I with a root in I. To approxi- mate the value of the root, accurate to d decimal places: 1. Choose a value xo as an initial...
-
Calculate the Debt Service Coverage Ratio in year 10 for a $100,000,000 capital project with a 50/50 debt equity ratio, a cost of debt of 8%, a first year revenue of $8,000,000, a revenue inflation...
-
An engineer wants to have a rough idea about the potential revenue of a run-of-river hydropower plant before performing any detailed computations. There are no measurements of streamflow, but based...
-
Costs of insurance vary by state, risk profile and amount of coverage. Visit insurance company websites and find out how much each of these insurance policies would cost you: home owner's insurance...
-
For the current year ended March 31, Cosgrove Company expects fixed costs of $527,000, a unit variable cost of $63, and a unit selling price of $94. Compute the sales (units) required to realize...
-
Explain how professionals in various concentrations (e.g., Marketing, Finance, Human Resources, etc.) within Retail could benefit from, or be constrained by, the application of these managerial...
-
1. Which must exist before a country can specialize its production? Responses an international division of labor government subsidies a global economy a free-market system 2. Which circumstances...
-
(5) (5) (5) (5) A rectangular cross-section suction wind tunnel is designed with a curved upper wall and a straight bottom wall. We are interested in characterising the boundary layer development...
-
Review networking in embedded systems and list the key features. What are the common types of networking used in embedded systems? What protocol does the ethernet follow? What are the advantages of...
-
Chris Zulliger was a chef at the Plaza Restaurant in the Snowbird Ski Resort in Utah. The restaurant is located at the base of a mountain. As a chef for the Plaza, Zulliger was instructed by his...
-
The risk-free rate of return, kRF, is 11 percent; the required rate of return on the market, kM, is 14 percent; and Upton Company's stock has a beta coefficient of 1.5. a. If the dividend expected...
-
What do the numbers on financial statements actually represent?
-
Refer to Problem 11-1. What is the project's NPV? In problem 11-1 Project K has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its cost of capital is 12...
-
The load resistor in the NMOS inverter in Figure \(16.3(\mathrm{a})\) is \(R_{D}=40 \mathrm{k} \Omega\). The circuit is biased at \(V_{D D}=3.3 \mathrm{~V}\). (a) Design the transistor...
-
The inverter circuit in Figure 16.3 (a) is biased at \(V_{D D}=3.3 \mathrm{~V}\). Assume the transistor conduction parameter is \(K_{n}=50 \mu \mathrm{A} / \mathrm{V}^{2}\). (a) Let \(R_{D}=100...
-
(a) Redesign the resistive load inverter in Figure 16.3 (a) so that the maximum power dissipation is \(0.25 \mathrm{~mW}\) with \(V_{D D}=3.3 \mathrm{~V}\) and \(v_{O}=0.15 \mathrm{~V}\) when the...
Study smarter with the SolutionInn App