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1.Suppose there are two firms, each with time period 1 cash flows of $1400 or $900 as shown below: Time period 0 -$800 Time period

1.Suppose there are two firms, each with time period 1 cash flows of $1400 or $900 as shown below:

Time period 0

-$800

Time period 1

Strong Economy: $1400

Weak Economy: $900

The firms are identical except for their capital structure. One firm is unlevered and its equity has a market value og $990. The other firm has borrowed $500, and its equity has a market value of $510. Does MM proposition 1 hold? What arbitrage opportunity is available using homemade leverage?

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