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http:/ing.cengage.com/static/ htmideploymentida 5830792994023680: · c !! e MindTap . Cengage Learn. MINDTAP Ch 06: Assignment- Fixed-Income Securities: Characteristics and Valuation Long-term debt offers advantages and disadvantages to the issuing firm and to the investor in debt securities. Examine the following two statements and indicate whether each represents an ad issuer or the investor. advantage or a disadvantage to the Debt securities containing provisions that provide the investor with flexibility or reduced risks, such as a conversion provision or a sinking fund, frequently impose costs or risks on the issuer Debt securities containing provisions that provide the issuer with flexibility, such as a call provision, frequently come at the expense of the debtholder. Does the preceding statement indicate an advantage or a disadvantage to the issuer or the investor in debt financing? Does the preceding statement indicate an advantage or a disadvantage to the issuer or the investor in debt financing? O Advantage to the issuer O Disadvantage to the issuer O Disadvantage to the investor O Disadvantage to the issuer Financial theory states that the use of dabt financing (also called financial leverage) increases the borrowing firm's earnings per share (EPS)-a5suming that everything else remains constant. Use the following example to prove or disprove the hypothesis: Assume that Acme Manufacturing Corporation generates annual sales of $875,000 using total assots of $500.000. It has an operating profit margin (EBIT/sales) of 45%, a tax rate of 35%, and 100,000 shares of common stock outstanding. These shares have a par value of $5 per share. Currently, t stock, but its management is considering which wm carry an interest rate of 15%, wa be used to repurchase an equal value of shares of common stock, with the company is financed solely with common selling sufficient debt to bring its debt ratio to 45%. These debt securities. their par value. Given this information, answer the questions in the follawing table: Presale Information what is the firm's current net income? what is the firm's current earnings per share? Postsale Information How many shares of common stock will the firm have outstanding if it sels ts new debe? what wll be the firm s eamings per share f it solls the nea debt?

Explanation / Answer

1.
Disadvantage to the issuer
2.
Disadvanateg to the investor
3.
Current Net Income=875000*45%*(1-35%)
=255937.5
4.
Current EPS=255937.5/100000
=2.559375
5.
New Debt=500000*45%=225000
New Equity=275000
Number of shares purchased=225000/5=45000
Number of shares outstanding=100000-45000=55000
6.
New Net Income=(875000*45%-15%*225000)*(1-35%)=234000
New EPS=234000/55000=4.254545455

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