DP Co. and TT Co. are identical firms in all respects except for their capital structure. DP is all equity financed with $850,000 in stock. TT uses both stock and perpetual debt, its stock is worth $425,000 and the interest rate on its debt is 9 percent. Both firms expect EBIT to be $90,000. Ignore taxes.

(i) Charlotte owns $42,000 worth of TTs stock. What rate of return is she expecting? (7 marks)

(ii) Show how Charlotte could generate exactly the same cash flows and rate of return by investing in DP using homemade leverage. (7 marks)

(iii) Given that R0=EBIT/S = 90,000/850,000= 10.59%. What is the cost of equity for DP? What is it for TT? (6 marks)

(iv) What is the WACC for DP? For TT? What principle have you illustrated? (10 marks)