Suppose there are no taxes. Firm ABC has no debt, and firm XYZ has debt of

$3,000

on which it pays interest of

10%

each year. Both companies have identical projects that generate free cash flows of

$3,500

or

$3,100

each year. After paying any interest on debt, both companies use all remaining free cash flows to pay dividends each year.

a. In the table below, fill in the debt payments for each firm and the dividend payments the equity holders of each firm will receive given each of the two possible levels of free cash flows.

b. Suppose you hold

10%

of the equity of ABC. What is another portfolio you could hold that would provide the same cash flows?

c. Suppose you hold

10%

of the equity of XYZ. If you can borrow at

10%,

what is an alternative strategy that would provide the same cash flows?