Question
Rain and Bow are two firms from the same industry. Rain generates an annual operating profit of $100,000 and Bow generates an annual operating profit
Rain and Bow are two firms from the same industry. Rain generates an annual operating profit of $100,000 and Bow generates an annual operating profit of $200,000. Rain is an all equity firm with 2 million shares which are trading at $10 per share. Bow has 2 million shares and debt value of $29 million. Suppose that both firms pay all of their free cash flows as dividend to their shareholders and that all debts are risk free.
A. Calculate the value of Bow.
B. Suppose you noticed that Bows stock is trading at $10 per share. Can you conclude that the stock is trading at fair value? (hint: first calculate Bows stock price according to the data you have and then, see if it fits the market price)
3. (OPTIONAL) If the answer to (b) is no, how can you exploit this situation in order to make a riskless profit today (what is the arbitrage opportunity here?)
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