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(2) Consider two firms: ABC: an all equity firm. It has 9 million common shares outstanding,...

  1. (2) Consider two firms:

ABC: an all equity firm. It has 9 million common shares outstanding, worth $40/share.

XYZ: is a levered firm with 4.6 million shares at $52.50/share. Its perpetual debt has a market value of $91 million and costs 8% a year.

They are identical in every other way. Both firms expect to earn $29 million before interest/year in perpetuity, with each company distributing all earnings as dividends. Neither pay taxes.

Assume the debt of XYZ is correctly priced. Which stock is a better buy? Show your work.

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Answer #1

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