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

question 51

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.
Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%. If Mike is right, what will Steve's payout be?

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Definitions:

Peer Groups

Social groups consisting of individuals of similar age, status, interest, or who regularly interact with each other, influencing behaviors, attitudes, and identities.

Accumulated Stresses

The progressive build-up of stress resulting from the accumulation of various stressors over time, potentially leading to adverse health outcomes.

Isolated Major Stress

A significant stressful event or situation that is distinct and separate from the ongoing stresses of everyday life, potentially having a profound impact on an individual's mental health.

Family Function

The roles and interactions within a family system that contribute to its members' emotional, physical, and social support and well-being.