ABC Corporation and XYZ Corporation are identical firms in all aspects except for their capital structure. ABC is financed by 100% equity. XYZ is financed by 80% equity and 20% debt. ABC's current cost of equity is 12%. XYZ's current cost of debt is 8%. The corporate tax rate is 30%.
What are XYZ's (i) cost of equity (3 pt); (ii) WACC? (3 pt)
(iii) Discuss why XYZ’s cost of equity is higher than that of ABC. (2 pt)
(iv) What’s ABC’s WACC? (2 pt)
(v) Discuss why XYZ’s WACC is less than that of ABC despite a higher cost of equity. (2 pt)