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

$2,000

on which it pays interest of

8%

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

$1,000

or

$1,100

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 and equity dividends 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

8%,

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

Question content area bottom

Part 1

a. In the table below, fill in the payments debt and equity holders of each firm will receive given each of the two possible levels of free cash flows. (Round to the nearest dollar.)

	ABC		XYZ
FCF	Debt Payments	Equity Dividends	Debt Payments	Equity Dividends
$1,000	$enter your response here	$enter your response here	$enter your response here	$enter your response here
$1,100	$enter your response here	$enter your response here	$enter your response here	$enter your response here

Part 2

b. Suppose you hold

10%

of the equity of ABC. What is another portfolio you could hold that would provide the same cash flow?(Select from the drop-down menus and round to the nearest integer.)

Buy

Sell

enter your response here%

of

XYZ

ABC

debt, and

Sell

Buy

enter your response here%

of

ABC

XYZ

equity.

Part 3

c. Suppose you hold

10%

of the equity of XYZ. If you can borrow at

8%,

what is an alternative strategy that would provide the same cash flow?(Select from the drop-down menus and round to the nearest integer.)

Sell

Buy

enter your response here%

of

ABC

XYZ

debt, and

Sell

Buy

enter your response here%

of

XYZ

ABC

equity.