Suppose there are no taxes. Firm ABC has no debt, and firm XYZ has debt of $5000 on which it pays interest of 9% each year. Both companies have identical projects that generate free cash flows of $1000 or $1300 each year. After paying any interest on debt, both companies use all remaining free cash flows to pay dividends each year.

a. Fill in the table above showing the debt payments and equity dividends each firm will receive given each of the two possible levels of free cash flows.

b. Suppose you hold 10% of the equity of ABC. What is another portfolio you could hold that would provide the same cash flows?

c. Suppose you hold 10% of the equity of XYZ. If you can borrow at 9%, what is an alternative strategy that would provide the same cash flows?

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FCF $ 800 $1000 ABC Debt Payments XYZ Equity Dividends Debt Payments Equity Dividends