Albo Corporation and Black Corporation are identical in every way except their capital structures. Albo Corporation, an all-equity firm, has 45 million shares of stock outstanding, currently worth $15 per share. Bluco Corporation uses leverage in its capital structure. The market value of Blco debt is $350mil., and its cost of debt is 4.5 percent. Each firm is expected to have earnings before interest and tax of $100mil. in perpetuity. Assume that every investor can borrow at 5 percent per year. Corporate tax rate is 40%.
Required:
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 15 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?
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Albo Corporation and Black Corporation are identical in every way except their capital structures. A...
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