Q1.

Wolfrum Technology (WT) has no debt. Its assets will be worth

$458

million one year from now if the economy is strong, but only

$263

million in one year if the economy is weak. Both events are equally likely. The market value today of its assets is

$284

million.

a. What is the expected return of WT stock without leverage?

b. Suppose the risk-free interest rate is

5%.

If WT borrows

$108

million today at this rate and uses the proceeds to pay an immediate cash dividend, what will be the market value of its equity just after the dividend is paid, according to MM?

c. What is the expected return of WT stock after the dividend is paid in part (b)

Q2.

Suppose there are no taxes. Firm ABC has no debt, and firm XYZ has debt of

$5,000

on which it pays interest of

10%

each year. Both companies have identical projects that generate free cash flows of

$5,300

or

$5,100

each year. After paying any interest on debt, both companies use all remaining free cash flows to pay dividends each year.

a. In the table below, fill in the debt payments for each firm and the dividend payments the equity holders of 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

10%,

what is an alternative strategy that would provide the same cash flows?

a. In the table below, fill in the debt payments for each firm and the dividend payments the equity holders of each firm will receive given each of the two possible levels of free cash flows.(Round all answers to the nearest dollar.)

	ABC		XYZ
FCF	Debt Payments	Equity Dividends	Debt Payments	Equity Dividends
$5,300	$nothing	$nothing	$nothing	$nothing
$5,100	$nothing	$nothing	$nothing	$nothing