ABC Co. and XYZ Co. are identical firms in all respects except for their capital
ID: 2774852 • 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 $800,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 5.2 percent. Both firms expect EBIT to be $79,000. Ignore taxes.
Rico owns $60,000 worth of XYZ’s stock. What rate of return is he expecting? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Suppose Rico invests in ABC Co. and uses homemade leverage. Calculate his total cash flow and rate of return. (Do not round intermediate calculations. Enter your rate of 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. 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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $800,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 5.2 percent. Both firms expect EBIT to be $79,000. Ignore taxes.
Explanation / Answer
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $800,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 5.2 percent. Both firms expect EBIT to be $79,000. Ignore taxes.
a.Rico owns $60,000 worth of XYZ’s stock. What rate of return is he expecting? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Net Income =( EBIT - Interest)*(1-tax Rate)
Net Income = (79000-400000*5.2%)*(1-0%)
Net Income = $ 58200
Expected Rate of return = Net Income / Common Stock
Expected Rate of return = 58200/400000
Expected Rate of return = 14.55%
Answer
Rate of return 14.55%
b.Suppose Rico invests in ABC Co. and uses homemade leverage. Calculate his total cash flow and rate of return. (Do not round intermediate calculations. Enter your rate of return answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Net Income =( EBIT - Interest)*(1-tax Rate)
Net Income = (79000-0)*(1-0%)
Net Income = $ 79000
Expected Rate of return = Net Income / Common Stock
Expected Rate of return = 79000/800000
Expected Rate of return = 9.875%
Total Cash Flow = 79000/800000 * 60000
Total Cash Flow = $ 5925
Total cash flow $ 5925
Rate of return 9.875%
c.What is the cost of equity for ABC and XYZ? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Cost of equity
ABC 14.55 %
XYZ 9.875 %
d.What is the WACC for ABC and XYZ? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
WACC for ABC = 9.875%
WACC for ZYZ = 50%*14.55% + 50%*5.2%
WACC for ZYZ = 9.875%
WACC :
ABC 9.875%
XYZ 9.875%