The Wannabee Company and the Gottahave Company are identical in every respect except that the Wannabee Company is not financially levered, whereas the Gottahave Company has $2 million in 12 percent bonds outstanding. There are no taxes, and capital markets are assumed to be perfect. The earnings of both companies are not expected to grow, and all earnings are paid out to shareholders in the form of dividends. The valuation of the two firms is shown as follows:

a. You own $22,500 worth of Gottahave stock. Show the process and the amount by which you could reduce your outlay through the use of arbitrage.
b. When will this arbitrage process cease?

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NABEE GOTTAHAVE Net operating income Interest on debt $ 600,000 0 600,000 s 600,000 240,000 S 360,000 0.16 $2,250,000 2,000,000 $4,250,000 0.1412 0.89 Earnings available to common shareholders (-1) k Equity capitalization rate -0.15 $4,000,000 Market value of stock (EIk) Market value of debt Total value of firm (B+ S) $4,000,000 0.15 k, mplied overall capitalization rate [k,(B/V) +k(S/V) BIS Debt-to-equity ratio