ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $575,000 in stock. XYZ uses both stock and perpetual debt; its stock isworth $287,500 and the interest rate on its debt is 8.5 percent. Both firms expect EBIT to be $64,000. Ignore taxes. a. Richard owns $34,500 worth of XYZ's stock. What rate of return is heexpecting? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. Suppose Richard invests in ABC Co. and uses homemadeleverage to match his cash flow in part (a). Calculate his total cash flow and rate of return. (Enter your return answer as a percent. Do not round intermediate calculations and round your answersto 2 decimal places, e.g., 32.16.) c. 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.) d. 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.)

A. To solve for the rate of return first solve for the net income EBIT 64000Less: Interest…

Answered: ABC Co. and XYZ Co. are identical firms…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Xtel Inc. with a total market value of $630 million has $30 million in excess cash and no debt. Xtel has 1 million shares outstanding. Xtelʹs board is meeng to decide whether to pay out its $30 million in excess cash as a special dividend or to use it to repurchase shares of the firm’s stock. You own 1,000 shares of Xtel stock. 1. Assume that Xtel uses the entire $30 million in excess cash to pay a special dividend. Calculate Xtelʹs ex-dividend price. Briefly explain your workings. 2. Assume that Xtel uses the entire $30 million to repurchase shares at a current share price. How many shares will Xtel repurchase? Briefly explain your workings.
North Pole and South Pole are competitors in the same industry. Both companies face a 23 % income tax rate. Both companies are levered. (North Pole and South Pole had the same equity Betas, 1.18, when they were still unlevered.) Their capital structures look like this: North Pole South Pole Debt $3,030,000 $3,940,000 Equity $3,940,000 $3,030,000 For both companies, the Betas for their debt is zero. Additional information about the market: The market portfolio's expected return is 12.1 %. The T-bill rate is 4.1 %. a. What is the Beta of equity for North Pole and South Pole? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b. In addition, calculate the required return on equity that would correctly reflect the level of systematic risk. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) a. b. North Pole South Pole. North Pole South Pole % %
Abacus Calculation Company and Zoom Calculators Inc. are identical except for capital structures. Abacus has 50% debt and 50% equity, whereas Zoom has 30% debt and 70% percent equity. The borrowings rate for both companies is 8% in a no tax world, and capital markets are assumed to be perfect. i. If you own 4 percent of the stock of Abacus, what is dollar return if the company has net operating income of $3,60000 and the overall capitalization rate of the company is 18%? ii. What is the implied required rate of return on equity? Zoom has the same net operating income as Abacus. What is the implied required equity return of Zoom? Why does it differ from that of Abacus?
Before any new financing, Sammy Ltd. has net income of $250,000 and 200,000 common shares outstanding. Ms. Sammy owns 65% of the shares and therefore has control of the company. Sam is considering two plans for raising $700,000 for expansion. Plan A: Borrow at 5% of capital obtained. Plan B: issue 50,000 common shares at $14 each. Management believes the expansion will generate additional income of $300,000 before interest and taxes. Ltd.’s income tax rate is 25%. Ms. Sammy plans to sell to Jayco Co, her best friend’s company, to raise capital if equity is used. These two have been in business for over 15 years, selling fashion accessories. Required: Analyze the above plans to determine which one will result in a higher net income; show calculations for costs included. Also indicate which is more favorable. Using the calculations done above in part 1, indicate which option is more favorable after calculating Earnings Per Share. Which plan do you think would/should be choosen?…
ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with $530,000 in stock. XYZ has the same total value but uses both stock and perpetual debt; its stock is worth $310,000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be $62,222. Ignore taxes. Compute the costs of equity for both ABC and XYZ.
Use below information for following two questions (Q24-Q25). AAA Corporation and BBB Corporation are identical in every way except their capital structures. AAA Corporation, an all-equity firm, has 35 million shares of stock outstanding, currently worth $25 per share. BBB Corporation uses leverage in its capital structure. The market value of BBB’s debt is $250mil., and its cost of debt is 3.5 percent. Each firm is expected to have earnings before interest and tax of $175mil. in perpetuity. Assume that every investor can borrow at 3.5 percent per year. Corporate tax rate is 35% and personal tax rate on bond interest income is 30%. Q24. What is the value of BBB corporations? $833.33 mil. $892.86 mil. $875 mil. $642.86 mil. $962.5 mil.
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $500,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $250,000 and the interest rate on its debt is 8 percent. Both firms expect EBIT to be $51,000. Ignore taxes. a. Richard owns $25,000 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.) b. 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. (Enter your return answer as a percent. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) c. 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.) d. What is the WACC for ABC and…
Roscoe Tours Ltd and Storebay Tours Ltd operate in the same geographical area and are close competitors. They are simply mirror images of each other and their financial records reflect the same as well in terms of an identical EBIT of $160,000. However, the fundamental difference is just that while Roscoe Tours is fully financed by equity, Mombay Tours follows a D/E ratio of 1. Both firms have assets worth $800,000 each and a share price of $25 each. The current market interest rate is 8% and both firms are enjoying a tax holiday because of the government policy to promote the tourism sector. Both Roscoe Tours Ltd and Mombay Tours Ltd follow a 100% dividend payout policy. As a young graduate, you are aware that the economy will bounce back in the coming year and knowing that leverage magnifies gains in good times, you have decided to invest $50,000 in Mombay Tours Ltd. You are required to answer the following questions: What is your proportional ownership in MombayTours Ltd.?…
McConn Manufacturing is currently all-equity financed, has an EBIT of $2 million, and has a corporate tax rate of 21 percent. Natalie, the company’s founder, is the lone shareholder. All earnings are paid out as dividends to Natalie. If the firm were to convert $4 million of equity into debt, the cost would be 10 percent and Natalie would hold all the debt. Assume Natalie pays personal taxes on interest income at a rate of 37 percent but pays taxes on dividends at a rate of 20 percent. Calculate the total cash flow to Natalie after she pays personal taxes if the firm is unlevered and if it is levered
You currently own 1,500 shares of JKL, Inc. JKL is an all equity that has 700,000 shares of stock outstanding at a market price of $25 a share. The company's earnings before interest and taxes are $3,500,000. You believe that the JKL should finance 50 percent of assets with debt, but management refuses to leverage the company. Given that similar firms' pay 9 percent interest on their debt, answer the following questions. Part A: How much money should you borrow to create the leverage on your own? Assume you can borrow funds at 9 percent interest. Part B. How many additional shares of JKL stock must you purchase (using the borrowed funds in Part A) to create the leverage on your own?
Xtel Inc. with a total market value of $630 million has $30 million in excess cash and no debt. Xtel has 1 million shares outstanding. Xtelʹs board is meeng to decide whether to pay out its $30 million in excess cash as a special dividend or to use it to repurchase shares of the firm’s stock. You own 1,000 shares of Xtel stock. Assume that Xtel uses the entire $30 million to repurchase shares. You are unhappy with Xtelʹs decision and would prefer that Xtel used the excess cash to pay a special dividend. As a result, you decide to create a “homemade” dividend. What is the number of shares that you would have to sell in order to receive the same amount of cash as if Xtel paid the special dividend? B
You are considering a stock investment in one of two firms (NoEquity, Inc., and NoDebt, Inc.), both of which operate in the same industry and have identical operating income of $32.5 million. NoEquity, Inc., finances its $65 million in assets with $64 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc., finances its $65 million in assets with no debt and $65 million in equity. Both firms pay a tax rate of 30 percent on their taxable income. Calculate the net income and return on assets for the two firms. Return on assets = net income / total assets Accounting equation: total assets = total liabilities debt + total equity

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