Question

Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 9,400 shares of stock outstanding, currently worth $22 per share. Beta Corporation uses leverage in its capital structure. The market value of Beta’s debt is $46,000, and its cost of debt is 12 percent. Each firm is expected to have earnings before interest of $48,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 12 percent per year.

Requirement 1:

What is the value of Alpha Corporation? (Do not include the dollar sign ($).)

Value of Alpha

$

Requirement 2:

What is the value of Beta Corporation? (Do not include the dollar sign ($).)

Value of Beta

$

Requirement 3:

What is the market value of Beta Corporation’s equity? (Do not include the dollar sign ($).)

Value of Beta’s equity

$

Requirement 4:

How much will it cost to purchase 18 percent of each firm’s equity? (Do not include the dollar signs ($).)

Cost for Alpha	$
Cost for Beta	$

Requirement 5:

Assuming each firm meets its earnings estimates, what will be the dollar return to each position in requirement 4 over the next year? (Do not include the dollar signs ($). Round your answers to the nearest whole dollar amount. (e.g., 32))

Return on Alpha	$
Return on Beta	$

Answer 1

a Value of Alpha $206,800 9400*22 b Value of Beta $206,800 c Market value of Beta's equity | $ 160,800 =206800-46000 Alpha Beta $ 37,224 -206800*18% $ 28,944 -160800*18% Alpha $ $ 8,640 =48000*18% 7,646 =(48000-46000*12%)* 18% Beta

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