Question
Eta Ltd. has no debt. Its management estimates there is a 70% probability that the companys assets will be worth $520 million in one year
Eta Ltd. has no debt. Its management estimates there is a 70% probability that the companys assets will be worth $520 million in one year if the economy is booming, and if it does not happen, its assets will be worth only $350 million. The current market value of Etas assets is $400 million.
a) What is the expected return of Eta stock without leverage? (3 marks)
b) Suppose the risk-free rate is 6.5%. If Eta borrows $200 million today at this rate and uses the proceeds to pay an immediate cash dividend, what will be the market value of its equity just after the dividend is paid, according to MM? (3 marks)
c) What is the expected return of Eta stock after the dividend is paid in Part b) above? (4 marks)
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