ABC Co. and XYZ Co. are identical firms in all respects except for their capital
ID: 2638852 • 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 $575,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $287,500 and the interest rate on its debt is 8.5 percent. Both firms expect EBIT to be $64,000. Ignore taxes.
Suppose Rico invests in ABC Co and uses homemade leverage. Calculate his total cash flow and rate of return.
What is the cost of equity for ABC and XYZ?
What is the WACC for ABC and XYZ?
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $575,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $287,500 and the interest rate on its debt is 8.5 percent. Both firms expect EBIT to be $64,000. Ignore taxes.
Suppose Rico invests in ABC Co and uses homemade leverage. Calculate his total cash flow and rate of return.
What is the cost of equity for ABC and XYZ?
What is the WACC for ABC and XYZ?
Explanation / Answer
Cash Flow ABC XYZ EBIT 64000 EBIT 64000 I 0 I 24437.5 T 0 T 0 NI 64000 NI 39562.5 Equity 575000 Equity 287500 Return 11.13% Return 13.76% Cost of equity ABC Ke 11.13% XYZ Ke 13.76% Kd 8.50% Wacc Ke*weight of equity+Kd*(1-t)*weight of debt ABC Wacc 11.13% XYZ Wacc 11.13%