Task:
The U Co. and the L Co. are identical in all aspects except that U Co. is all-equity financed while L Co. has $1,000 debt in 6% perpetual bonds outstanding (on which $60 of interest is paid each year). Both firms have expected net operating income of $300 (forever). Both firm distribute as dividends all income available to shareholders. There are no taxes. Assume no agency costs or bankruptcy costs. The cost of equity is 10% for the U Co. and 12% for the L co.
Q1. What is the market value of the L Co.?
A) $2,000
B) $1,000
C) $3,000
D) $6,000
Q2. What is the cost of capital for the L Co.?
A) 9%
B) 8%
C) 10%
D) 12%
Q3. What is the total income available annually to the U Co.'s security holders?
A) $300
B) $155
C) $65
D) $240