Topic
• Alpha NV and Beta NV are identical in every way except their capital structures.
• Alpha NV, an all-equity firm, has 5,000 shares of equity outstanding, currently worth €20 per share.
• Beta NV uses leverage in its capital structure. The market value of Beta’s debt is €25,000, and its cost of debt is 12 percent.
• Each firm is expected to have earnings before interest of €35,000 in perpetuity
• Neither firm pays taxes. • Assu
me that every investor can borrow at 12 percent per year.
Questions
a. What is the value of Alpha NV? (10 points)
b. What is the value of Beta NV? (10 points)
c. What is the market value of Beta NV’s equity? (10 points)
d. How much will it cost to purchase 20 percent of each firm’s equity? (10 points)
e. Assuming each firm meets its earnings estimates, what will be the euro return to each position in part (d) over the next year? (20 points)
f. Construct an investment strategy in which an investor purchases 20 percent of Alpha’s equity and replicates both the cost and dollar return of purchasing 20 percent of Beta’s equity. (20 points)
g. Is Alpha’s equity more or less risky than Beta’s equity? Explain. (20 points)
