Suppose there are two firms, Walmart and Amazon. Both firms will have the same cash...
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Suppose there are two firms, Walmart and Amazon. Both firms will have the same cash flows at the end of the year: $300M if the economy is strong and $150Mif the economy is weak. Both scenarios are equally likely. The two firms are identical except for their capital structure.Amazon is unlevered and has 20M shares outstanding,which are currentlytrading at a market price of $10.50. Walmart has corporate bonds outstanding with a market value of $100Mand a credit rating of AAA, as well as 20M shares at a current market price of $5.00. You can ignore taxes.a)What is the market capitalization and D/E ratio of Walmart and Amazon?b)Does M&M proposition 1hold? Explain.c)Suppose you can borrow at the risk-freeinterest rate of 5%. Is there an arbitrage opportunity available using homemade leverage?If yes, present a detailed strategy to exploit the arbitrage opportunity.(how much of each security would you buy / sell, what is your arbitrage profit)d)What is the expected rate of return of Walmarts equity?e)What is going to happen to Walmarts and Amazons stock prices if many traders execute the arbitrage strategy you proposed in (c)? Explain.
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