ABC Co. and XYZ Co. are identical firms in all respects except for their capital
ID: 2475888 • Letter: A
Question
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $475,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $237,500 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be 553,000. Ignore taxes. Richard owns $23,750 worth of XYZ's stock. What rate of return is he expecting? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Suppose Richard invests in ABC Co. and uses homemade leverage to match his cash flow in part a. Calculate his total cash flow and rate of return. (Do not round intermediate calculations. Enter your return answer as a percent rounded to 2 decimal places, e.g., 32.16.) What is the cost of equity for ABC and XYZ? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) What is the WACC for ABC and XYZ? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)Explanation / Answer
ABC XYZ nature all eq both equity 475000 237500 debt 0 237500 total 475000 475000 EBIT 53000 53000 Less:interest 23750 net income 53000 29250 rate 11.16% 12.32% a 12.32% b first $ 23750 is received by selling stock in XYZ then $ 23750 is borrowed at 10% and now total of $ 47500 is invested to earn 12.32% c ABC XYZ cost of equity 11.16% 12.32% d ABC XYZ WACC 11.16% 11.16%