Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 10 million shares outstanding that trade for a price of $8 per share. With has 5 million shares outstanding and $20 million in debt at an interest rate of 5%.

Assume Miller and Modigliani (MM) perfect capital markets with no taxes and that firms and individuals can borrow and lend at the same 5% rate as With.

1. Assume that MM's perfect capital market conditions are met and that you can borrow and lend at the same 5% rate as With. You have $5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock?

b. According to MM Proposition 1, which firm would you invest in if the equity of With was valued at $65 million? Briefly justify your choice.