Question
The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. Financial information for the two firms appears
| The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. Financial information for the two firms appears in the following table. All earnings streams are perpetuities, and neither firm pays taxes. Both firms distribute all earnings available to common stockholders immediately. |
| Veblen | Knight | ||||
| Projected operating income | $ | 900,000 | $ | 900,000 | |
| Year-end interest on debt | ? | $ | 85,000 | ||
| Market value of stock | $ | 3,900,000 | $ | 2,450,000 | |
| Market value of debt | ? | $ | 1,700,000 | ||
| a-1 | What will the annual cash flow be to an investor who purchases 5 percent of Knight's equity? |
| Cash flow | $ |
| a-2 | What is the annual net cash flow to the investor if 5 percent of Veblen's equity is purchased instead? Assume that borrowing occurs so that the net initial investment in each company is equal. The interest rate on debt is 5 percent per year. |
| Net cash flow | $ |
| b. | Given the two investment strategies in (a), which will investors choose? | ||||
|
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Liquidity Risk Management In Banks Economic And Regulatory Issues
Authors: Roberto Ruozi, Pierpaolo Ferrari
1st Edition
3642295800, 978-3642295805
