Question
Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 5,000 shares of stock outstanding,
Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 5,000 shares of stock outstanding, currently worth 20 per share. Beta Corporation uses leverage in its capital structure. The market value of Betas debt is 25,000. The cost of this debt is 12% per annum. Each firm is expected to have earnings before interest of 350,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 12%.
Construct an investment strategy in which an investor purchases 20% of Alphas equity and replicates both the cost and return of purchasing 20% of Betas equity.
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