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) You own $56,250 worth of XYZs stock. What rate of return are you expecting?

B) Calculate the cash flows and rate of return by investing in ABC and using homemade leverage, how could you 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?