ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $750,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $375,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $73,000. Ignore taxes.

A.

Kathy owns $56,250 worth of XYZ's stock. What rate of return is she expecting?

B.

Calculate the cash flows and rate of return by investing in ABC and using homemade leverage, how Kathy could generate exactly the same returns.

C.

What is the cost of equity for ABC? What is it for XYZ?

D.What is the WACC for ABC? For XYZ? What do you conclude?