Consider two firms L and U which are identical in all aspects except for capital structure. The EBIT and cost of capital for each firm is Sh. 900,000 and 10% respectively. U is an all-equity financed firm while L has 7.5% of Sh.4, 000,000 debt.

a. Estimate the value of levered firm (L) and Unlevered firm (U) using Net Income (NI) approach;

b. Establish whether there is an arbitrage opportunity

c. Estimate the arbitrage profits if any by considering an investor who holds 10% of the stock of overvalued firm