Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

This is all the info that I was given. Please don't tell me that you need more info. Please show all work. Thank you! Suppose

image text in transcribed

This is all the info that I was given. Please don't tell me that you need more info. Please show all work. Thank you!

Suppose there are two firms, Walmart and Tesla. Both firms have the same cash flows in year 1: $300M if the economy is strong, and $150M if the economy is weak. Both scenarios are equally likely. The firms are identical except for their capital structure. Tesla is unlevered and has 10M shares outstanding which are currently trading at a market price of $20.50. Walmart has corporate bonds outstanding with a market value of $100M and a credit rating of AAA, as well as 5M shares at a current market price of $20.00. You can ignore taxes. a) What is the market capitalization and D/E ratio of Walmart and Tesla? b) Does M&M proposition I hold? Explain. c) Suppose you can borrow at the risk-free interest rate of 5%. Is there an arbitrage opportunity available using homemade leverage? If yes, present a detailed strategy to exploit the arbitrage opportunity. d) What is the expected rate of return of Walmart's equity? e) What is going to happen to Walmart's and Tesla's stock prices if many traders execute the arbitrage strategy you proposed in (c)? Explain. Suppose there are two firms, Walmart and Tesla. Both firms have the same cash flows in year 1: $300M if the economy is strong, and $150M if the economy is weak. Both scenarios are equally likely. The firms are identical except for their capital structure. Tesla is unlevered and has 10M shares outstanding which are currently trading at a market price of $20.50. Walmart has corporate bonds outstanding with a market value of $100M and a credit rating of AAA, as well as 5M shares at a current market price of $20.00. You can ignore taxes. a) What is the market capitalization and D/E ratio of Walmart and Tesla? b) Does M&M proposition I hold? Explain. c) Suppose you can borrow at the risk-free interest rate of 5%. Is there an arbitrage opportunity available using homemade leverage? If yes, present a detailed strategy to exploit the arbitrage opportunity. d) What is the expected rate of return of Walmart's equity? e) What is going to happen to Walmart's and Tesla's stock prices if many traders execute the arbitrage strategy you proposed in (c)? Explain

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Public Finance

Authors: Richard W. Tresch

4th Edition

0128228644, 978-0128228647

More Books

Students also viewed these Finance questions

Question

Suggest strategies to reduce resistance to change

Answered: 1 week ago

Question

=+ (a) Show that C is uncountable but trifling.

Answered: 1 week ago

Question

What were your most important educational experiences?

Answered: 1 week ago

Question

Which personal relationships influenced you the most?

Answered: 1 week ago