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Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L has $20,000 of debt that pays 8%
Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike has $6,000 and can choose to invest in the equity of firm U or firm L. Which of the following statements is true? Assume that operating income is $2, 500 for both firms, that borrowing or lending on a personal account faces the same interest rate as corporate debt and that there are no taxes. Mike can buy 20% of firm U and borrow $4,000 and he will generate the same payoff as investing in firm L. Mike can buy 10% of firm U and lend $1,000 and he will generate the same payoff as investing in firm L. Mike can buy 30% of firm U and borrow $9,000 and he will generate the same payoff as investing in firm L. Mike can buy 10% off firm Land lend $3,000 and he will generate the same payoff as investing in firm U. Mike can buy 40% of firm L and borrow $6,000 and he will generate the same payoff as investing in firm U
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