Paula Worth, a private wealth advisor who saw your analysis of LewCo, approaches you with an idea. She says that your $1000 investment in 20 shares produces a cash flow stream of $63 next year with 5% growth per year. Using leverage (borrowing) she proposes to increase the cash flow fivefold (after fees) to $315 the first year with 5% growth after that. She argues that the value of this investment is $5,000 based on the r* = 11.3%, but it only costs you $1000.
a. Use the formulas from class to illustrate how Paula arrived at the value of $5,000.
b. What mistake did she make in applying the formula?
c. What might Modigliani-Miller say about your paying Paula Worth a fee for this service?