Homemade Leverage and WACC Verpfndung AG and Zeit AG are identical firms in all respects except for

Homemade Leverage and WACC Verpfändung AG and Zeit AG are identical firms in all respects except for their capital structure. Verpfändung is all equity financed, with

€500,000 in equity shares. Zeit AG uses both shares and perpetual debt; its equity is worth €250,000, and the interest rate on its debt is 10 per cent. Both firms expect EBIT to be €100,000. Assume that both firms maintain a dividend payout rate of 100 per cent and that the book value exactly resembles the market value for both debt and equity. Ignore taxes.

(a) Robert owns €25,000 worth of Zeit AG’s shares. What rate of return is he expecting if the payout ratio is 50 per cent?

(b) What is the cost of equity for Verpfändung? What is it for Zeit?

(c) What is the WACC for Verpfändung? For Zeit? What principle have you illustrated?