Computation of cost of equity, rate of return and wacc

Reference no: EM139953

Computation of cost of equity, Rate of return and WACC

Homemade leverage and WACC. 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%. Both firms expect EBIT to be $90,000. 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 home made leverage (i.e., by borrowing at the risk free rate of 10%.)

(d) What is the WACC for ABC? For XYZ? What principle have you illustrated?

Reference no: EM139953

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