Question

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 4.5 percent. Both firms expect EBIT to be $67,000. Ignore taxes. a. Richard owns $36,000 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. (Do not round intermediate calculations. 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 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.) Rate of return 14.33 % a. b. Total cash flow Rate of return ABC cost of equity C. XYZ cost of equity ABC WACC XYZ WACC d.

Answer 1

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ke - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins - 2x % Cut Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General Ea Copy Fill Paste B I U - D SF A Merge Merge & Center Center $ - % % Sort & 4:0 .00 Find & 8. Conditional Format Cell Insert Delete Format Format Painter Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing QD1260 Fax 2 PT PU PV PW PX PY PZ QA QB Formula Bar QD QE QE QG Q H QI 1258 ABC XYZ 1259 EQUITY 600000 300000 1260 DEBT 300000 1261 TOTAL 600000 600000 1262 1263 RICHARD HAS INVESTMENT IN XYZ 1264 1265 RICHARD INVESTMENT 36000 1266 1267 EBIT 67000 1268 LESS : INTEREST 13500 (300000 x 4.5%] 1269 CASH FLOW FOR SHAREHOLDERS 53500 1270 1271 CASH FLOW TO RICHARD 6420.00 [53500 x 36000/300000] 1272 RATE OF RETURN 17.83% [6420/30000] 1273 1274 RICHARD INVESTMENT IN XYZ = 12% [36000/300000] 1275 NOW INVESTMENT REQUIRED IN ABC 72000 (12% x 600000] 1276 LESS: AVAILABLE AMOUNT 36000 1277 SO BORROWING 36000 1278 M CoNvexity DGM betaport future INDEX INTL CAP BUD SANDRINE LEASING PV, FV, ANNUITYDIR right clean YIELD bond portfolio WACC RESI DIV POLICY NAME DIV YIELD I- Rea ferences: CF670 BO! 120% - ...B 9 . * O ENG 08-12-2019 H

1281 1285 ke - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins - 2x * Cut Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General E Copy Fill Paste Sort & B Find & I U B- A $ -% Merge & Center - . Format Painter Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing QD1297 Box _ PT PU PV PW PX PY PZ QA QB Q C QD QE QF QG Q H QI 1278 1279 EBIT OF ABC 67000 1280 LESS: INTEREST CASH FLOW FOR SHAREHOLDERS 67000 1282 1283 CASH FLOW FROM DIVIDEND 8040 (67000 x 72000/600000 1284 LESS: INTEREST PAID ON BORROWING 1620 [36000 x 4.5%) CASH FLOW TO RICHARD 6420 1286 (SAME AS XYZ) 1287 RATE OF RETURN 8.92% (6420/72000] 1288 1289 COST OF EQUITY 1290 ABC EBIT/ VU =67000/600000 = 11.17% AS IT IS UNLEVERED XYZ re = ru + (D/S)(ru-rd) 17.83% [re = 11.17% + (300000/300000) (11.17%-4.5%)] 1292 WACC 1294 11.17% AS IS UNLEVERED 1295 XYZ WACC = Wd *rd + We*re 11.17% WACC =0.5*(4.5%)+0.5*(17.83%) 1296 1297 1298 M CoNvexity DGM betaport future INDEX INTL CAP BUD SANDRINE LEASING PV, FV, ANNUITYDIR right clean YIELD bond portfolio WACC RESI DIV POLICY NAME DIV YIELD I- Rea ferences: CF670 BO! 120% - ...B 9 . * O ENG 08-12-2019 1291 1293 ABC H