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Question 2. Levered Inc. and Unlevered Inc. are identical companies with identical business risk. Their earnings are perfectly correlated. Each company is expected to earn
Question 2. Levered Inc. and Unlevered Inc. are identical companies with identical business risk. Their earnings are perfectly correlated. Each company is expected to earn $96 million per year in perpetuity, and each company distributes all its earnings. Levered Inc. has debt that provides a return of 8% and has a market value of $275 million. Levered's stock sells for $100 per share and there are 4.5 million shares outstanding. There are no taxes, no bankruptcy costs and no costs of financial distress. Unlevered Inc. has 10 million shares outstanding worth only $80 each. Unlevered Inc. has no debt. (a) (6 points) Which stock is the better investment and how could an arbitrageur take advantage of the asset mispricing
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