ABC Co. and XYZ Co. are identical firms in all respects except for their capital
ID: 2682608 • Letter: A
Question
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $600,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $300,000 and the interest rate on its debt is 11 percent. Both firms expect EBIT to be $65,700. Ignore taxes.(Do not include the percent signs (%). Round your answers to 2 decimal places. (e.g., 32.16))
The WACC for ABC ispercent, and for XYZ ispercent. This is an illustration of (Click to select) MM Proposition II without taxes MM Proposition I with taxes MM Proposition I without taxes MM Proposition II with taxes.
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $600,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $300,000 and the interest rate on its debt is 11 percent. Both firms expect EBIT to be $65,700. Ignore taxes.(Do not include the percent signs (%). Round your answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
The rate of return earned will be the dividend yield. The company has debt, so it must make an interest payment. The net income for the company is:
NI = $$65,700– .11($300,000)
NI = $65700 –33000 =32700
The investor will receive dividends in proportion to the percentage of the company’s share they own. The total dividends received by the shareholder will be:
Dividends received = $32700 ($30,000/$300,000)
Dividends received = $3270
So the return the shareholder expects is:
R = $3270/$30,000 =0.109= 10.09%