d for operation: $11,000
Problem 20-03
Fill in the table using the following information.
Assets required for operation: $11,000
Firm A uses only equity financing
Firm B uses 30% debt with an 8% interest rate and 70% equity
Firm C uses 50% debt with a 10% interest rate and 50% equity
Firm D uses 50%
Earnings before interest and taxes: $1,100
If your answer is zero, enter "0". Round your answers for monetary values to the nearest cent. Round your answers for percentage values to one decimal place.
| A | B | C | D | |||||
| Debt | $ | $ | $ | $ | ||||
| Preferred stock | $ | $ | $ | $ | ||||
| Common stock | $ | $ | $ | $ | ||||
| Earnings before interest and taxes | $1,100.00 | $1,100.00 | $1,100.00 | $1,100.00 | ||||
| Interest expense | $ | $ | $ | $ | ||||
| Earnings before taxes | $ | $ | $ | $ | ||||
| Taxes (40% of earnings) | $ | $ | $ | $ | ||||
| Preferred stock dividends | $ | $ | $ | $ | ||||
| Income available to common stockholders | $ | $ | $ | $ | ||||
| Return on common stock | % | % | % | % |
What happens to the common stockholders' return on equity as the amount of debt increases? Why is the rate of interest greater in case C? Why is the return lower when the firm uses preferred stock instead of debt?
Other things equal, the return on common stock as the firm uses financial leverage. As the firm becomes financially leveraged ( in financial risk), the rate of interest will increase. The return is lower when the firm uses preferred stock instead of debt because the are not tax deductible as opposed to the .
Which type of financing involves less risk for the firm?
Assuming a comparable use, is less risky to the firm.
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