St$.$ Louis Co$.$ and St$.$ Romuald Co$.$

are identical firms in all respects except for their capital structure. St$.$ Louis is

all$-$equity financed with $$780,000$ in stock. St$.$ Romuald uses both stock and

perpetual debt; its stock is worth $$390,000$ and the interest rate on its debt is

$8\%.$ Both firms expect EBIT to be $$87,000.$ Ignore taxes.

a$.$ Clifford owns $$48,750$ worth of St$.$ Romuald$$s stock. What rate of return is he

expecting?

b$.$ Show how Clifford could generate exactly the same cash flows and rate of

return by investing in St$.$ Louis and using homemade leverage.

c$.$ What is the cost of equity for St$.$ Louis? What is it for St$.$ Romuald?

d$.$ What is the WACC for St$.$ Louis? For St$.$ Romuald? What principle have you

illustrated?