Section A Question 3 Assume a Modigliani-Miller (MM) world. AntiVaxer, PaleoBro, and Boop are three similar com- panies in the wellness industry with the following capital structures and cash flows: AntiVaxer PaleoBro Boop Shares outstanding (millions) 10 6 20 Share price $30 $35 $10.50 105 390 45 45 90 Market value of perpetual debt (Smillion) Expected earnings before interest ($million) Interest expense (Smillion) Dividends (Smillion) 5.25 19.5 45 39.75 70.5 All three firms share identical business and operating risk characteristics, producing perfectly correlated earnings. Expected earnings will remain constant in perpetuity. All earnings are paid out as interest or dividends every year, these payouts are also expected to remain constant. When answering the question, state any additional assumptions you may need to make. Show all working/calculations. (a) Calculate the market-implied weighted average cost of capital (WACC) for AntiVaxer and PaleoBro. Explain why your results indicate the presence of an arbitrage opportunity. [4 marks] (b) You work for Paltrow Capital, a fund manager that currently holds 8% of the debt issued by PaleoBro. Show that by taking positions in the equity of AntiVaxer and PaleoBro, your employer can profitably exchange its current holdings for an alternative investment with identical future cash flow characteristics. Make sure to fully demonstrate the arbitrage. [5 marks] (c) Your friend owns 500,000 Boop shares. How would you replicate the future cash flows of your friend's investment using a leveraged equity holding in Paleo Bro? Assume you can borrow and lend at 5%. [6 marks]