Consider a financial market without frictions in which all the assumptions of the Modigliani-Miller paradigm hold. Consider two identical firms

generating the same cash flow X = 11000 EUR in one year. The two firms are liquidated right afterward. The two firms differ only in their capital

structure. One firm is financed entirely with equity (unlevered firm). The other firm (levered firm) is financed partly with equity and partly with debt, D >

O. The levered firm pays an interest rate r= 10% over its debt next year, which corresponds to the risk-free interest rate. The debt of the levered firm

is risk-free. In order to find the present value of any firms' securities, the investors operating on the market discount the future cash-flows at the risk-

free interest rate (i.e. investors are risk-neutral). Let U be the present value of the unlevered firm and let L be the present value of the levered firm.

What is the present value of the two firms? What is (in EUR) the arbitrage profit you can gain by buying 1% of the unlevered firm's equity today, if its

present value U was lower than L and if you can borrow money at the same rate as the levered firm?

) (a) The present value of both firms equals 10000 EUR; the arbitrage profit you can gain is 100 + 0.01U (EUR)

) (b) The present value of both firms equals 10000 EUR; the arbitrage profit you can gain is 100 - 0.01U (EUR)

(c) The present value of both firms equals 9000 EUR; the arbitrage profit you can gain is 10 EUR

(d) The present value of both firms equals 11000 EUR; the arbitrage profit you can gain is 100 EUR