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Computation of cost of equity and weighted average cost of capital (WACC)
Firm A and Firm B are identical in all respects except for their capital structure. Firm A is all equity financed with $800,000 in stock. Firm B uses both stock and perpetual debt; its stock is worth $400,000 and the interest rate on its debt is 10 percent. Both firms expect EBIT to be $90,000. Ignore taxes.
a.What is the cost of equity for Firm A and Firm B?
b. What is the weighted average cost of capital (WACC) for Firm A and Firm B?
c. What conclusions can you draw from your results from Parts (c) and (d) above?
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