Problem 16-9 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 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. Rate of return b. Total cash flow % b. Rate of return % c. ABC cost of equity % c. XYZ cost of equity % d. ABC WACC % d. XYZ WACC %

EBK CFIN

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ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter12: Capital Structure

Section: Chapter Questions

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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 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.)

Problem 16-9 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 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. Rate of return
b. Total cash flow
%
b. Rate of return
%
c. ABC cost of equity
%
c. XYZ cost of equity
%
d. ABC WACC
%
d. XYZ WACC
%

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