Problem: Consider two firms A and B that are identical in all respects except capital structure. Firm A has $160 million in equity outstanding and $40 million in bonds outstanding. Firm B has $200 million in equity outstanding and $0 million in bonds outstanding.
Question1. Assume an investor has an $8 million investment in stock of firm A. What alternative $8 million investment that includes firm B’s stock will give the investor the same cash flow payoff in upcoming years as his current investment in firm A’s stock?
Question2. Assume an investor has a $16million investment in stock of firm B. What alternative $16million investment which comprises firm A’s stock will give the investor the same cash flow payoff in upcoming years as his current investment in firm B’s stock?