he Day Company and the Knight Company are identical except that Day is not levered. Financial

information for the two firms appears in the following table. All earning streams are perpetuities, and

neither firm pays tax. Both firms distribute all earnings available to common stockholders immediately.

DAY KNIGHT

Projected Operating Income R$325000$ R$325000$

Year$-$end interest on debt $-$ R$48000$

Market Value of Stock R$210000$ R$1500000$

Market Value of Debt $-$ R$800000$

a$)$ An investor who can borrow at $6\%$ per year wishes to purchase $5\%$ of Knight$$s equity. Can

he increase his dollar return by purchasing $5\%$ of Day$$s equity if he borrows so that the initial net

costs of the strategies are the same?

b$)$ Given the two investment strategies in part $($a$),$ which will investors choose $?$ When will this

process cease?