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[solution] » 4. (20) Suppose Alpha Industries and Omega Technology have identical assets that generate identic


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4. (20) Suppose Alpha Industries and Omega Technology have identical assets that generate identical cash flows. Alpha Industries is an all-equity firm, with 10 million shares outstanding trading for a price of $22 per share. Omega Technology has 20 million shares outstanding, as well as debt of $60 million.

a) According to MM Proposition 1, what should be the share price for Omega Technology?

b) Suppose shares of Omega Technology currently trade for $11 per share. What arbitrage opportunity is available? What assumptions are necessary to exploit this opportunity?


Q a).

 

Value of Alpha = Value of Omega

 

Value of Alpha = Equity

 

= 22*10,000,000

 

= $220,000,000

 

Value of Omega = Debt + Equity

 

= $220,000,000

 

Debt = $60,000 Therefore equity = 220,000,000-60,000,000

 

=...

 


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