Companies A and B differ only in their capital structure. A is financed 30% with riskless debt and 70% with equity; B is financed entirley with equity. Both companies operate in a perfect capital market and earn $200,000 of operating income each year. Assume both A and B have a market value of $1m and 10,000 shares outstanding. Risk-free interest rate is %10.
A) Mr X can buy 1% of A's equity for $7,000. Find another $7,000 portfolio that would produce identical cash flows from him using stock B and riskless borrowing or lending. (Must prove identical cash flows).
B) Mr. Y can by 2% of B's equity for $20,000. Find another $20,000 portfolio that would produce identical cash flows from him using stock A and riskless borrowing or lending.