ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $480,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 11 percent. Both firms expect EBIT to be $58,400. Ignore taxes. The cost of equity for ABC is _____ percent, and for XYZ it is ______ percent.
A)12.17; 12.68
B)12.17; 12.94
C)12.17; 13.33
D)12.29; 12.68
E)12.29; 13.33

Question

Quizplus · Accepted Answer

ABC: R_E = R_A = $58,400/$480,000 = 12.17 percentXYZ: R_E = 0.1217 + (0.1217 - 0.11)(1)(1) = 13.33 percentNote: ABC: Equity = $480,000XYZ: Equity = $240,000; Debt = $480,000 - $240,000 = $240,000

ABC Co and XYZ Co