Question 2 Two firms, U and L. are identical except for their capital structure. Both will earn $150 in a boom and $50 in a slump. There is a 50% chance of each event happening every year from now on i.e. every year is either a boom or a slump, independent of the previous year). U is entirely equity financed, and therefore shareholders receive the entire income as dividend every year. Its shares are currently valued at $500. L has $400 of perpetual risk-free debt at an interest rate of 10%, and therefore $40 of L's income is paid out as interest There are no taxes or other market imperfections so investors can borrow and lend at the risk-free rate (d) Show that M&M's proposition II holds for your answer to partc (ie., show that the relationship between the expected returns of your investments with identical payoffs is the one predicted by proposition II)