Question

# ABC and XYZ are identical firms in all respects except for their capital structures. ABC is...

ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with \$530,000 in stock. XYZ has the same total value but uses both stock and perpetual debt; its stock is worth \$310,000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be \$62,222. Ignore taxes. The cost of equity for ABC is _____ percent and for XYZ it is ______ percent.

Select one:

11.74; 9.82

11.74; 12.48

11.74; 14.47

12.09; 9.82

12.09; 12.48

ABC Firm:

ABC is all equity financed company = \$530,000

As in ABC there is no debt, and there is no taxes as well. Thus, EBIT is the Net Income = \$62,222

Cost of Equity for ABC = Net Income/Total Equity

= \$62,222/\$530,000

= 11.74%

XYZ Firm:

XYZ uses both Equity as well as perpetual Debt, Its Equity portion = \$310,000

Perpetual Debt portion = \$ 530,000 - \$ 310,000 = \$ 220,000

Interest on Perpetual Debt = \$220,000*7.9% = \$17,380

Net Income = EBIT- Interest

= \$62,222 - \$ 17,380

= \$ 44,842

Cost of Equity for ABC = Net Income/Total Equity

= \$44,842/\$310,000

= 14.47%

Hence, Option C. 11.74% , 14.47%

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