Question: 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 percent. Both firms expect EBIT to be $97,000. Ignore taxes.
Part a: Rico owns $80,000 worth of XYZ's stock. What rate of return is he expecting?
Part b: Suppose Rico invests in ABC Co. and uses homemade leverage. Calculate his total cash flow and rate of return
Part c: What is the cost of equity for ABC and XYZ?
Part d: What is the WACC for ABC and XYZ?