There Are Two Companies, U and L, Which Are Identical

question 56

Essay

There are two companies, U and L, which are identical in every respect, except that U is financed entirely through common equity and L has $100,000 in debt at an interest rate of 16%.Both companies achieve annual net operating earnings of $45,000.Assume perfect markets and information, with no taxes and no bankruptcy costs.If the market capitalizes firm U at a rate of 10%, and the total market value of L is $500,000, is there an arbitrage opportunity available, and if so, what is the net gain?

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Definitions:

Influential

Having the power to affect the beliefs or behaviors of people or the outcome of events.

Psychology

The scientific study of the mind and behavior, encompassing various aspects of human thought, emotion, and action.

Dream Analysis

A therapeutic technique used in psychoanalysis to interpret the latent content of dreams, aiming to uncover unconscious thoughts and desires.

Childhood Experiences

Events, interactions, and moments occurring during one's childhood that can significantly influence an individual's development and personality.