ABC Company and DEF Company are competitors, and being in the same industry they have tried to

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Question:

ABC Company and DEF Company are competitors, and being in the same industry they have tried to be very similar to each other with one significant difference. The CEO of ABC hates debt and the CEO of DEF thinks that debt is good for the income statement and improves DEFs return on equity. Here are the salient facts to consider:

ABC Company has 10,000 shares of common stock outstanding, and each share is worth $20.

The capital structure of DEF Company is $50,000 in debt with interest payments at 12% annually.

The total capitalization of ABC and DEF are the same.

Both firms think they will have earnings of $55,000 a year continuously and because of their costs, neither firm pays any taxes. For the purposes of this problem, investors can also borrow money at 12% annually.

a) What is the value of ABC Company?

b) What is the value of DEF Company?