Consider Two Firms,U and L,both with $50,000 in Assets

question 70

Essay

Consider two firms,U and L,both with $50,000 in assets. Firm U is unlevered,and firm L has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding,while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion,and that with the possibility of borrowing on his own account at 8% interest,he can replicate Mike's payout from firm L.
Given a level of operating income of $2,500,show the specific strategy that Mike has in mind.

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Definitions:

American Participation

The involvement of the United States in international or domestic events, ranging from wars to political movements.

Vietnam War

A prolonged conflict from the 1950s to the 1975 between North Vietnam (supported by its communist allies) and South Vietnam (supported by the United States and other anti-communist countries), resulting in significant political and social upheaval.

Détente

A period of improved relations and reduction in tensions between countries, especially notable between the United States and the Soviet Union during the Cold War.