There are two firms, BW and GT. Each has expected Net Operating Income (NOI) of $5 million each year forever, and the NOI to BW will always be exactly the same as that to GT. After any interest payments, all income is paid out to equity holders. The riskiness of each company’s assets suggests a fair weighted average cost of capital of 10 percent. BW is all equity (stock). GT has some equity, along with $20 million (market value and face value) in perpetual debt. GT’s debt pays risk-free 6% interest each year. There are no taxes.
a. What is the value of BW equity?
b. What is the value of GT equity?
c. What is the expected return on GT stock?