Question

Using the Modigliani-Miller (MM) theory in a perfect market, you can identify a current situation in...

Using the Modigliani-Miller (MM) theory in a perfect market, you can identify a current situation in the market as follows. ABC Industries and XYZ Technology have identical assets that generate identical cash flows. ABC Industries is an all-equity firm, with 15 million shares outstanding that trade for a price of $20 per share. XYZ Technology has debt of $100 million as well as 20 million shares outstanding that trade for a price of $8 per share. To exploit this current situation for a risk-free profit, you understand that you can use homemade leverage and should take the following transactions:

A. Buy ABC Stock; Sell XYZ Stock; and Lend

B. Sell ABC Stock; Buy XYZ Stock; and Lend

C. Buy ABC Stock; Sell XYZ Stock; and Borrow

D. Sell ABC Stock; Buy XYZ Stock; and Borrow

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Answer #1

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