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ID: 2618684 • Letter: E
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e scroll wheel to zoom. Go to settings to change what the scroll wheel does. Go to Settings Suppose there are no taxes Finn ABC has no debt, and firm XYZ has debt that generate free cash flows of $900 or $1,300 each year a. In the table below, fill in the debt payments 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 equa ty of XYZ If you can borrow at 13%, what is an alternative strategy that would provide the same cash nows? of $3,000 on which it pays interest of 13% each year Both companies have identical propos . After paying any interest on debt, both companies use all remaining free cash flows to pay dividends each year and irm will r ABC YZ FCF $900 $1,300 Debt Payments Equity Dividends Debt Payments Equity DividendsExplanation / Answer
(a) The business ABC has no debt, so debt payments will be 0. The entire cash flow generated will be paid as equity dividends. For the XYZ company, there is a debt of 3000 on which interest is 13%. So debt payments would be 0.13*3000 = 390 in each case and the remaining would be paid as equity dividends.
(b) Unlevered Equity = Debt + Levered Equity. Buy 10% of XYZ debt and 10% of XYZ equity you get the same return as holding 10% in ABC
You hold 10% equity in ABC, you get $90 in interest which is the same as 0.10*390+0.10*510 = 39+51 =90
So answer is : BUY 10% of XYZ debt and BUY 10% of XYZ Equity
(c)Levered Equity = Unlevered Equity + borrowing. Here we Borrow $500 and buy 10% of Equity of ABC to get the same return as holding 10% in XYZ
So answer is : BORROW $500 and BUY 10% of ABC Equity
ABC XYZ FCF Debt Payment Equity dividends Debt Payments Equity Payments 900 0 900 390 900-390 =510 1300 0 1300 390 900-390=910Related Questions
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