Black Co. and White Co. are identical firms in all respects except for their capital structure. Black is all equity financed with $800,000 in stock. White 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. Required: 1. Ali owns $30,000 worth of White’s stock. What rate of return is he expecting? 2. Show how Ali could generate exactly the same cash flows and rate of return by investing in Black and using homemade leverage. 3. What is the cost of equity for Black? What is it for White? 4. What is the WACC for Black? For White? What principle have you illustrated?
Black Co. and White Co. are identical firms in all respects except for their capital structure. Black is all equity financed with $800,000 in stock. White 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. Required: 1. Ali owns $30,000 worth of White’s stock. What rate of return is he expecting? 2. Show how Ali could generate exactly the same cash flows and rate of return by investing in Black and using homemade leverage. 3. What is the cost of equity for Black? What is it for White? 4. What is the WACC for Black? For White? What principle have you illustrated?
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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Black Co. and White Co. are identical firms in all respects except for their capital structure. Black is all equity financed with $800,000 in stock. White 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.
Required:
1. Ali owns $30,000 worth of White’s stock. What
2. Show how Ali could generate exactly the same cash flows and rate of
3. What is the
4. What is the WACC for Black? For White? What principle have you illustrated?
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