ABC Co and XYZ Co

question 60

Multiple Choice

ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $480,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 11 percent. Both firms expect EBIT to be $58,400. Ignore taxes. The cost of equity for ABC is _____ percent, and for XYZ it is ______ percent.

• A)12.17; 12.68
• B)12.17; 12.94
• C)12.17; 13.33
• D)12.29; 12.68
• E)12.29; 13.33

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Definitions:

Return on Investment

A measure of the profitability and efficiency of an investment, calculated by dividing net profits by the cost of the investment.

Residual Income

Profit remaining after deducting all costs, including the cost of capital, usually used in managerial accounting as a performance measure.

Minimum Required Rate of Return

The lowest rate of return that a potential investment must offer to be considered acceptable, taking into account the investor's cost of capital and risk appetite.

Annual Turnover

The total sales or revenue a company generates in one year.