Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation,...

 

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Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 5,000 shares of stock outstanding, currently worth $20per share. Beta Corporation uses leverage in its capital structure. The market value of Beta's debt is $25,000 and its cost of debt is 12 percent. Each firm is expected to have earnings before interest of $35,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 12 percent per year. (a) What is the value of Alpha Corporation? (b) What is the value of Beta Corporation? (c) What is the market value of Beta Corporation's equity? (d) How much will it cost to purchase 20 percent of Each firm's equity? (e) Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year? What will be the ROE for each position? (f) Construct an investment strategy in which an investor purchases 20 percent of Alpha's equity and replicates both the cost and dollar return of purchasing 20 percent of Beta's equity. (g) Is Alpha's equity more or less risky than Beta's equity? Explain. Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 5,000 shares of stock outstanding, currently worth $20per share. Beta Corporation uses leverage in its capital structure. The market value of Beta's debt is $25,000 and its cost of debt is 12 percent. Each firm is expected to have earnings before interest of $35,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 12 percent per year. (a) What is the value of Alpha Corporation? (b) What is the value of Beta Corporation? (c) What is the market value of Beta Corporation's equity? (d) How much will it cost to purchase 20 percent of Each firm's equity? (e) Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year? What will be the ROE for each position? (f) Construct an investment strategy in which an investor purchases 20 percent of Alpha's equity and replicates both the cost and dollar return of purchasing 20 percent of Beta's equity. (g) Is Alpha's equity more or less risky than Beta's equity? Explain.

Answer rating: 100% (QA)

a Since Alpha Corporation is an all equity firm its value is equal to the market value of its outstanding shares Alpha has 5000 shares of common stock outstanding each worth 20 per share Therefore the ... View the full answer