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Suppose there are two firms with the same perpetual cash flow, EBIT = $1500. The firms are identical except for their capital structure. Firm U is unlevered and Firm L is levered with a perpetual debt. The current values of the firm are Vu = $15,000 and VL = $19,000. The current value of debt is D = $10,000. Corporate tax rate, t = 35%, and cost of debt, Rd = 5%. Is there an arbitrage opportunity? If so, how would you exploit it? Assume tax is the only imperfection.

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Financial Management, Finance

Category:- Financial Management
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