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:

Overcrowding

A situation where too many people or items are contained within a space designed for significantly fewer, often leading to discomfort and hazards.

Recidivism

The tendency of a convicted criminal to reoffend.

Behavioral Controls

Strategies or mechanisms put in place to guide or modify individual behavior.

Total Institution

A place of residence and work where a large number of like-situated individuals, cut off from the wider community, live in an enclosed formally administered round of life.