Question: Problem 1. Modigliani-Miller Consider a world without taxes and two firms which are identical except for their financial structures: D has a 800M debt (the

Problem 1. Modigliani-Miller Consider a world without taxes and two firms which are identical except for their financial structures: D has a 800M debt (the interest rate is 4%), whereas E is 100% equity. Both firms have a 120M operating income. The market value of E's equity is 1000M while the market value of D's equity is 700M. 1. Compute D's and E's cost of equity, WACC (Weighted Average Cost of Capital) and leverage. 2. Which of the 2 firms is overvalued? 3. Show, under the assumptions of MM, that an investor owning a 100,000 equity stake in Firm D can by arbitraging increase his return or alternatively decrease his level of investment while earning the same revenue. 4. What is the total value of the 2 firms, the value of their equity, their cost of equity and their leverage if the WACC is 10% and there is no more arbitrage opportunity? 5. Is M-M's assumption realistic? Problem 1. Modigliani-Miller Consider a world without taxes and two firms which are identical except for their financial structures: D has a 800M debt (the interest rate is 4%), whereas E is 100% equity. Both firms have a 120M operating income. The market value of E's equity is 1000M while the market value of D's equity is 700M. 1. Compute D's and E's cost of equity, WACC (Weighted Average Cost of Capital) and leverage. 2. Which of the 2 firms is overvalued? 3. Show, under the assumptions of MM, that an investor owning a 100,000 equity stake in Firm D can by arbitraging increase his return or alternatively decrease his level of investment while earning the same revenue. 4. What is the total value of the 2 firms, the value of their equity, their cost of equity and their leverage if the WACC is 10% and there is no more arbitrage opportunity? 5. Is M-M's assumption realistic

Step by Step Solution

There are 3 Steps involved in it

1 Expert Approved Answer

Step: 1 Unlock blur-text-image

Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock

Step: 3 Unlock

Students Have Also Explored These Related Finance Questions!

On March 1, Year 9, Saskatchewan Inc., a Canadian company with a December 31 year-end, invested the sum of 2,640,000 Swiss francs (CHF) in Norktel, a Swiss telecommunications company. On the...

Why is it important for us to understand how the global system of financial institutions and markets works? ros57395_ch01.qxd 12/21/04 2:45 PM Page 1 Part 1 The Global Financial System in Perspective...

Synthesis: Significance and Implications of Alternative Accounting Principles Learning Objectives Web Refer to Figure 1. Circle A indicates the universe of possible accounting principles. The dashed...

need answers for questions 13, 17, 19, 20, and 23? PART 5 Business Valuations Chapter Business Valuations A valuation analyst should be able to explain and defend his or her valuation, including both...

need answer for these questions 13, 17, 19, 20, and 23? PART 5 Business Valuations Chapter Business Valuations A valuation analyst should be able to explain and defend his or her valuation, including...

currency) will play a dominant role in the world and will - possibly - replace some previously established businesses (if not the whole markets). But - to achieve such a supremacy - changes are...

To whom it may concern is it possible to have the unanswered questions answered? Question 1 0 out of 1 points Which of the following events would make it more likely that a company would choose to...

See page 129- 137 on attachment for more details there are five steps to the project. Step 1: Create the loan amortization schedule for the property. Step 2: Create the depreciation schedule. Step 3:...

Case Analysis 1. Compute the yield to maturity of Land'o'Toys' bonds before the purchase announcement and use it to determine the likely current bond rating. (Compare YTM to the table on p. 269)....

Explore the differences in the japanese and american investment decision-making processes and the conflicts that arise from there. TOKYO DISNEYLAND AND THE DISNEYSEA PARK: CORPORATE GOVERNANCE AND...

This is a Macroeconomics question. 1.1 An innitely lived household (40 points) Consider a representative household who maximizes her lifetime utility (as in class): 00 max 'U(ct, ll) 0 (Ct ,Nft...

Joey Department Store's employees are paid on the 6th and 22rd of each month for the period ending the last day of the previous month and the 15th of the current month, respectively. An analysis of...

T F T F T F T F T F T T T T T T T T T T Use the given sequence to determine the values of n1 n2, the number of runs G, and the 5% cutoff values from Table A-10.

If you leave no will, probate courts distribute your property, unless you held your assets in a tlving trust. your assets were jointly owned or payable to others. you owned assets of little value. a...

A company is preparing completing their Cash Budget. The following data has been prepared for cash receipts and payments. January February March Cash receipts $1,061,200 $1,182,400 $1,091,700 Cash...