Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £50m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where...

Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £50m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk free rate. Some of the relevant numbers are provided in the following table (in £ m):

A. In the absence of arbitrage opportunities, the value of B is £100m

B.  In the absence of arbitrage opportunities, B’s weighted average cost of       capital is 10%

C.  In the absence of arbitrage opportunities, B’s return on equity is 15%

D.  In the absence of arbitrage opportunities, B’s return on equity is higher than A’s return on equity.

Extracted text: A Value of Firm 100 Debt 50 Equity 100 Earnings before interest 10 10 Interest payment 2.5 Interest rate Not Applicable 5% B.