Suppose there are no taxes. Firm ABC has no debt, and firm XYZ has a debt
of $5000 on which it pays interest of 10% each year. Both companies have identical projects that
generate free cash flows of $800 or $1000 each year. After paying any interest on debt, both
companies use all remaining free cash flows to pay dividends each year.
a)Fill in the table below showing the
payments debt and equity holders of each firm will receive given each of the
two possible levels of free cash flows.
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 equity of
XYZ. If you can borrow at 10%, what is
an alternative strategy that would provide the same cash flows?