5. BAC Co. and YXZ Co. are identical firms in all respects except for their capital structure. BAC is all equity financed with $800,000 in stock. YXZ uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $95,000. Ignore taxes. a. Richard owns $30,000 worth of YXZ's stock. What rate of return is he expecting? b. Show how Richard could generate exactly the same cash flows and rate of return by investing in ABC and using homemade leverage.

5. BAC Co. and YXZ Co. are identical firms in all respects except for their capital structure. BAC is all equity financed with $800,000 in stock. YXZ uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $95,000. Ignore taxes. a. Richard owns $30,000 worth of YXZ's stock. What rate of return is he expecting? b. Show how Richard could generate exactly the same cash flows and rate of return by investing in ABC and using homemade leverage.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 7P

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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 10 percent. Both firms expect EBIT to be $95,000. Ignore taxes. a. Richard owns $30,000 worth of XYZ’s stock. What rate of return is he expecting? b. Show how Richard could generate exactly the same cash flows and rate of return by investing in ABC and using homemade leverage. c. What is the cost of equity for ABC? What is it for XYZ? d. What is the WACC for ABC? For XYZ? What principle have you illustrated?
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a. Richard owns $33,000 worth of XYZ's stock. What rate of return is he expecting? Rate of return b. Calculate the cash flows and rate of return by investing in ABC, and using homemade leverage, how Richard could generate exactly the same? Total cash flow Rate of return ABC XYZ % c. What is the cost of equity for ABC? What is it for XYZ? Cost of equity ABC XYZ $ d. What is the WACC for ABC? For XYZ? WACC %