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An unlevered firm is levered by buying back some of the shares using cash and replacing the cash by issuing debt. In the next period,

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An unlevered firm is levered by buying back some of the shares using cash and replacing the cash by issuing debt. In the next period, it is distributing its cash profits as dividends. Compute the volatility (standard deviation) of stock returns of the levered firm and unlevered firm using the information given below and comment on the relation between them. Note: No taxes. No change in fixed assets and working capital (excluding cash) The price of the stock doesn't change with repurchases. All profits are cash profits. The profits are distributed as dividends. No of sharesn outstanding Price per share Unlevered firm 1000 15 Possible outcomes 500 1000 1500 2000 Operating income Earnings per share Return on share% Levered firm No of shares bought back 200 Price per share Debt amount raised Interest rate 0.2 Possible outcomes Operating income 500 Interest Earnings per share Return on share% 1000 1500 2000

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