Worksheet #2. Work Sheet - Arbitrage Purchase the less expensive package, sell short the more expensive package, pocket the difference, positions cancel out down the road. Suppose Vy > V EU = Vu = $1500 Firm sells debt for $900 today, promise to pay back $1000 tomorrow Market prices equity of levered firm at $550 VL - $550 + $900 = $1450 (1) Stakeholder cash flows Expectation Recession 1/3 800 Normal 1/3 1800 Boom 1/3 2800 Probability Total firm cash flow Cash flow to unlevered equity Cash flow to levered equity Cash flow to bondholders