EQ Limited and DEQ Inc are identical firms in all respects except for their capital structure.

EQ is an all equity firm with a market value of $10,000,000.

DEQ which also has a market value of $10,000,000 uses both stock and perpetual debt. DEQ has a

debt/equity ratio of 3/5. Its cost of debt is 8%.

Both firms expect EBIT to be $1,500,000 per year forever. Ignore taxes.

a. Justine owns $200,000 worth of DEQ Inc. stock. What rate of return is she expecting?

b. Show how she could generate exactly the same cash flows and the rate of return by investing in EQ

Limited and using the homemade leverage.

c. What is the cost of equity for EQ? For DEQ?

d. What is the rWACC for EQ? For DEQ? What is your conclusion?