Question
ABC Corporation has total assets of $1,000. Currently, it is an all equity firm. There are three possible economic scenarios and the ROA in these
ABC Corporation has total assets of $1,000. Currently, it is an all equity firm. There are three possible economic scenarios and the ROA in these scenarios are as follows: in recession, the ROA is 5%; in the expected scenario, the ROA is 15%; and in expansion, the ROA is 25%. The current stock price is $10.
An investor has $120 to invest, but he would like to invest in the same firm with a different capital structure, that with a debt-equity ratio of 1:4. In order to create the same effect of investing in the stated levered firm, he decides to create homemade leverage. In order to do that, he must:
A. Buy 13 shares and borrow $10
B. Buy 14 shares and borrow $20
C. Buy 15 shares and borrow $30
D. Buy 16 shares and borrow $40
E. None of the above
Please show your work for the above problem
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