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Wolfrum tech.(WT) has no debt. Its assets wiil be worth $450 million in one year if the economy is strong, but only $200 million in one year if the economy is weak. Both events are equally likely. The market value today of assets is $250 million.

a) What is the expected return of WT stock without leverage?

b) Suppose the risk-free interest rate is 5%. If WT borrows $100 million today at this rate and uses the proceeds to pay immediate cash dividends, what will be the market value of its equity just after the dividend is paid, according to MM?

c) What is the expected return of MM stock after the dividend is paid in part (b)?

 

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