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Levered and Unlevered are two companies with identical business risk. Their earnings are perfectly correlated.

  Levered and Unlevered are two companies with identical business risk. Their earnings are perfectly correlated. Each company is expected to earn $96M per year in perpetuity and they distribute all of their earnings. Levered's debt has a market value of $275M and yields 8%. Levered stock sells at $100/share and there are 4.5M shares outstanding. Unlevered has 10M shares outstanding with a price of $80 per share. Unlevered has no debt. There are no taxes. Which stock is a better investment?

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Decision: The levered firm's equity is undervalued as its... View the full answer

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