What other package would produce the identical cash flow

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Reference no: EM131615714

Company E is financed with 30% debt and 70% equity while Company O is financed with 100% equity. The firms are alike in all but thier capital structure and they can borrow at the risk free rate which is 10%. Flowers owns 1% of the common stock of company E. What other package (I mean an investment in company O) would produce the identical cash flow for Flowers? SHow all of your work and also show that the cash flows for the investment strategies are the same. Note that you are purchasing the stock of the less-levered firm and then furtherlevering up the investment yourself. Assume that the total value of E is $100 and is comprised of $30 of debt (at 10% interest) and $70 of equity (which earns a 20% return). This will coincide with interest expense of $3 per year for Company E and earnings to equity holders of $14 per year. Similarly, assume Company O is composed of $0 of debt and $100 of equity (17% exoected return on equity).

Reference no: EM131615714

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