1. What is its cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5. If it had no debt, its cost of equity would be 16%. Its current cost of debt is 12%.
2. ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all-equity financed with $550,000 in stock. XYZ uses both stock and perpetual debt in equal proportions; its stock is worth $275,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $59,000 every year, forever. Ignore taxes.
A.
a. Richard owns $33,000 worth of XYZ’s stock. What rate of return is he expecting? Rate of return B.
b. Calculate the cash flows and rate of return by investing in ABC, and using homemade leverage, how Richard could generate exactly the same?
c. What is the cost of equity for ABC? What is it for XYZ?

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Question 1 Cost of levered equity rs ru 1 tax x DE x ru rd 16 1 40 x 15 x 16 12 196 Question 2 Solu... View the full answer