An industry is composed of three firms of the same size, with the same number of shares outstanding, and with similar operational efficiency (E[EBIT1] = [E[EBIT2] = E[EBIT3]). However the firms have different capital structures and different share values as expressed in the following table, Firm E[EBIT] RA D # shares Price per share 1 15,000 10% 100,000 100,000 0.6 2 15,000 10% 50,000 100,000 1 3 15,000 10% 0 100,000 1.25

a. A financial analyst of this industry issues a recommendation to hold for firm 2, a recommendation to buy for firm 3 and a recommendation to sell for firm 1. Is the analyst right in making such recommendations?

b. Assume that all the investors in this industry act on the analyst recommendations, what will happen to the shares of firms 1, 2 and 3?