Question
Consider two firms, RATM Inc. and RHCP Inc., that have identical assets that generate identical cash flows. RHCP is an all-equity firm, with 1.2 million
Consider two firms, RATM Inc. and RHCP Inc., that have identical assets that generate identical cash flows. RHCP is an all-equity firm, with 1.2 million shares outstanding that trade at a price of $21 per share. RATM has 3.0 million shares outstanding and $16 million of debt at an interest rate of 5%.
Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as RATM. You have $5000 of your own money to invest and you plan on buying RHCP stock. Using homemade leverage you borrow enough so that the payoff of your purchase of RHCP stock will be the same as a $5000 investment in RATM stock. Calculate the number of shares of RHCP stock you purchased.
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