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It is 2006 and you notice that there are a lot of television programs about people that flip houses. That is, programs in which people buy houses, remodel them, and house to sell them at a profit. You think that this sounds intriguing and consider buying a house to sell one year later.

Assume that this house cost $2M today. The house, after you remodel it, will take on one of five market values next year: $1.40M, $1.70M, $2M, $2.30M, or $2.60M. Assume that remodeling the house is costless.

a. Suppose you have $2M in cash and decide to buy the house. What is your percentage return for each of the five possible house values next year? Graph your percentage return on the y-axis versus the percentage change in value of the house on the x-axis. Draw a straight line through the five points. HInt: this is a triial case where your percentage return exactly equals the percentage change in the value of the property.

b. Suppose you only have $1.50M in cash. Your friend agrees to lend you the remaining $0.50M that you need, but only if you pay him back with 10% interest as soon as you sell the house one year later. You get the cash that is left over after selling the house and replaying your friend. Graph your percentage return on your personal $1.50M investment on the y-axis versus the percentage change in the value of the property on the x-axis. Draw a straight line through five points.

c. Now suppose you only have $0.70M in cash. Your friend agrees to lend you the remaining $1.25M that you need, but only if you pay back with 10% after you sell in one year. Graph the percentage return on your personal investment $0.75M on y-axis versus the percentage change in value on the property on the x-axis. Draw a straight line through five points.

d. Comment on the slope of lines from the previous three questions. Which scenario appears riskiest for your personal cash investment?

e. stock returns are more risky when a firm has a higher percentage of debt on its balance sheet. Brieftly comment on how this statement relates to your results.

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