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(i) You were examining the financial statements of Company Y and estimated that the expected return of investing in Company Y is 10%. Your required
(i) You were examining the financial statements of Company Y and estimated that the expected return of investing in Company Y is 10%. Your required return of this investment is 11%. The next day you encountered your friend Tom. He told you that he just invested in Company Y yesterday. Do you think that he has made a wise decision? (ii) Company A is currently trading at $11.7 per share while Company B is currently trading at $2 per share. On Company A's balance sheet, it reports $5 million cash and liabilities worth of $5 million. The number of outstanding shares for Company A and Company B are 1 million and 7 million, respectively. Company A's financial statements consolidate an 85 percent interest in Company B. Assume that the book value of liabilities is the same as its market value. Is there an arbitrage opportunity? Discuss. (i) You were examining the financial statements of Company Y and estimated that the expected return of investing in Company Y is 10%. Your required return of this investment is 11%. The next day you encountered your friend Tom. He told you that he just invested in Company Y yesterday. Do you think that he has made a wise decision? (ii) Company A is currently trading at $11.7 per share while Company B is currently trading at $2 per share. On Company A's balance sheet, it reports $5 million cash and liabilities worth of $5 million. The number of outstanding shares for Company A and Company B are 1 million and 7 million, respectively. Company A's financial statements consolidate an 85 percent interest in Company B. Assume that the book value of liabilities is the same as its market value. Is there an arbitrage opportunity? Discuss
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