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Firms A and B are identical except for their capital structure. A carries no debt,...

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Finance

Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries 40m of debt on which it pays a 5% interest rate. Assume no transaction costs, no taxes and risk-free debt. The relevant numbers are provided in the following table (in m):

A B

Value of Firm

Debt 0 40

Equity 100 80

Earnings before interest 10 10

Interest payment

Interest rate Not Applicable 5%

Earnings after interest

Return on Equity

Debt/Equity Ratio

Cost of Capital

a. Reproduce the above table in your answer booklet filling the blank spaces. b. Consider an investor holding a stake y, 0

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