Company E is financed with 30% debt and 70% equity while Company O is financed with 100% equity. The firms are alike in all but their capital structure and they can borrow at the risk-free rate which 10%. Flowers owns 1% of the common stock of Company E. What other package (an investment in Company O) would produce the identical cash flow for Flowers? Assume that total value of E is $100 and is composed of $30 of debt and $70 of equity (which requires a 20% return). This will coincide with interest expense of $3 per year for E and earing to equity holders of $14 per year. Similarly, assume that O is composed of $0 of debt and $100 of equity (17.0% required rate of return on equity)
Please include the work, especially work showing that the cash flows are identical.