Firm A and B have the same capital structure. A: No debt. B: have £100m debt and pay 5% interest rate. Assume: no tax and perfect capital market. The firm lend and borrow at same risk-free rate....

Firm A and B have the same capital structure. A: No debt. B: have £100m debt and pay 5% interest rate. Assume: no tax and perfect capital market. The firm lend and borrow at same risk-free rate.

Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant.

1）What is the profit from arbitrage? (Answer: 25 or 0.25)

2)The after interests return from the investor’s position? (Answer: 1)

3)What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt? (Answer: 6.25 or 625)

How to calculate this result?

Extracted text: A В Value of Firm 200 250 Debt 100 Equity 200 150 Earnings before interest 20 20 Interest payment 5 Interest rate Not Applicable 5%