You work for the CEO of a new company that plans to manufacture and sell a new p
ID: 2752095 • Letter: Y
Question
You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $400,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEu? Oper. income (EBIT) $400,000 $400,000 Required investment $2,500,000 $2,500,000 % Debt (weight of) 0.0% 60.0% $ of Debt $ $0.00 $1,500,000 $ of Common equity $2,500,000 $1,000,000 Interest rate NA 10.00% Tax rate 35% 35% 5.85% 6.14% 6.45% 6.77% 7.11% With the same information from question 38, if the stock price is $80 per share, what would be the earnings per share under the leveraged capital structure? S8.00 $10.25 $11.50 $13.00 $13.67Explanation / Answer
0% Debt 60% Debt Operating Income (EBIT) $ 400,000.00 $ 400,000.00 Required Investment $ 2,500,000.00 $ 2,500,000.00 Debt $ - $ 1,500,000.00 Common Equity $ 2,500,000.00 $ 1,000,000.00 Interest Rate 10% Tax Rate 35% 35% Ans 38 ROE EBIT $ 400,000.00 $ 400,000.00 less:Interest $ - $ 150,000.00 Earning Before Tax $ 400,000.00 $ 250,000.00 Less :TAX $ 140,000.00 $ 87,500.00 EAT $ 260,000.00 $ 162,500.00 ROI=EAT/Common Equity*100 $ 10.40 $ 16.25 Difference $ 5.85 Answer is (A) ANS 39 60% Debt Common Equity $ 1,000,000.00 Stock Price $ 80.00 Number of shares 12500 EBIT $ 400,000.00 less:Interest $ 150,000.00 Earning Before Tax $ 250,000.00 Less :TAX $ 87,500.00 EAT $ 162,500.00 EPS=EAT/No. of Shares $ 13.00 Answer is (D)
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