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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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…
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
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