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ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure....

ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $500,000 of equity. XYZ uses both equity and perpetual debt; its equity is worth $280,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $60,000. Ignore taxes (i.e. Modigliani-Miller without taxes or other frictions).

Compute the cost of equity for ABC.

Compute the cost of equity for XYZ.

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Particulars ABC Co. XYZ Co.
EBIT $       60,000.00 $                      60,000.00
Less: Interest (10% of 220,000) $                      -   $                      22,000.00
EBT $       60,000.00 $                      38,000.00
Less: Tax $                      -   $                                     -  
Earning after tax(for shareholders) $       60,000.00 $                      38,000.00
Equity $    500,000.00 $                    280,000.00
Debt $                      -   $                    220,000.00
Cost of equity(Earning after tax/Equity) 12.00% 13.57%

jeff jeffy answered 1 year ago
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