question archive Consider two firms, Firm L and Firm U, that have identical assets that generate identical cash flows
Consider two firms, Firm L and Firm U, that have identical assets that generate identical cash flows
Subject:FinancePrice:3.87 Bought7
Consider two firms, Firm L and Firm U, that have identical assets that generate identical cash flows. Firm U is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm L has 2 million shares outstanding and $12 million in debt at an interest rate of 5%.
Assume that Modigliani and Miller's (1958) perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as Firm L. You have $5,000 of your own money to invest and you plan on buying Firm U stock. Using homemade leverage, you borrow enough in your margin account so that the payoff of your margin purchase of Firm U stock will be the same as a $5,000 investment in Firm L stock. The number of shares of Firm U stock you purchased is closest to
Select one:
a. 208
b. 21
c. 417
d. 1667
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
Answer:
As per MM approach,value of levered firm is equal to value of unlevered firm,thus the market value of firm L shall be equal to market value of firm U and thereby share price of both firm shall be same i.e. $24
Thus,no. of shares that can be purchased with $10000 is closest to;
=$10,000/$24=416.67 shares
=417 shares
thus correct answer is option C
