Explore BrainMass
Share

# payoff structure

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

I would be grateful for an explanation to the attached problem.

© BrainMass Inc. brainmass.com October 24, 2018, 7:30 pm ad1c9bdddf
https://brainmass.com/economics/contracts/payoff-structure-69706

#### Solution Summary

Assess the payoff structure.

\$2.19

## Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a \$5000 investment in With stock? According to MM Proposition 1, the stock price for With is closest to.

1) Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of \$24 per share. With has 2 million shares outstanding and \$12 million dollars in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as with. You have \$5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a \$5000 investment in With stock?
a) \$10,000
b) \$5000
c) \$2,500
d) \$0

2) Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of \$24 per share. With has 2 million shares outstanding and \$12 million dollars in debt at an interest rate of 5%. According to MM Proposition 1, the stock price for With is closest to:
a)\$8.00
b)\$24.00
c)\$6.00
d)\$12.00

View Full Posting Details