. Homemade Leverage and WACC [LO1] ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all-equity financed with $600,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $300,000 and the interest rate on its debt is 8 percent. Both firms expect EBIT to be $80,000. Ignore taxes. a. Rico owns $30,000 worth of XYZ's stock. What rate of return is he expecting? b. Show how Rico 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? eac no debt. The weighted average cost of capital is

. Homemade Leverage and WACC [LO1] ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all-equity financed with $600,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $300,000 and the interest rate on its debt is 8 percent. Both firms expect EBIT to be $80,000. Ignore taxes. a. Rico owns $30,000 worth of XYZ's stock. What rate of return is he expecting? b. Show how Rico 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? eac no debt. The weighted average cost of capital is

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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Question 2Firm U is an all equity firm and has a market value of $100,000 and EBIT of $300,000. Firm L has identical EBIT but it uses 40% debt in its capital structure. Firm L pays total annual interest of $3000 on its debt. Both firms satisfy the MM assumptions. Taxes are absent.a) Ryan is the holder of $9,000 worth of L’s stock. What rate of return can he expect, assuming a dividend pay-out of 100%?b) Using homemade leverage, show how Ryan could generate exactly the same cash flows and rate of return by investing in Firm U.
Homemade Leverage and WACC ABC Company and XYZ Company are identical firms in all respects except for their capital structure. ABC is all-equity financed with $650,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $325,000 and the interest rate on its debt is 6.5 percent. Both firms expect EBIT to be $71,000. Ignore taxes. a. Rico owns $39,000 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 Rico invests in ABC Company and uses homemade leverage to match his cash flow in part (a). Calculate his total cash flow and rate of return. (Do not round intermediate calculations and enter your return answer as a percent rounded 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…
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which one is correct answer please confirm? Q26: Sharp's current capital structure of 60% equity, 35% debt, and 5% preferred stock is considered optimal. This year Sharp expects to have earnings after tax of $3.6 million and to pay out $600,000 in dividends. Sharp can also raise up to $2 million in long-term debt at a pretax interest rate of 10.6% (all debt over $2 million will cost 11.4% pretax), and sell preferred stock at a cost of 11.5%. Sharp's marginal tax rate is 40%. The current value of Sharp's common stock is $36 and a dividend of $2.15 is expected to be paid during the coming year. Dividends have been growing at an annual compound rate of 8% a year and are expected to continue growing at that rate. New shares can be sold to net the firm $34.50. Sharp has an opportunity to invest in the following capital projects. Which one(s) should be accepted? Project Cost Annual Cash Flow Project Life 1 $3.0 million $552,893 10 years 2 $2.5 million…