Suppose that Seattle Health Plans use zero-debt financing. It's operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all equity financed, $5 million equity. The firm's profit, total dollar return to investors, and return on equity under these conditions are listed below. Suppose that the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent A) What impact would the new capital structure have on the firm's profit, total dollar return to investors, and return on equity? B) Redo the analysis, but now assume that the debt financing would cost 15 percent. C) Repeat the analysis required for question A, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Balance Sheets Total Assets $5,000,000 Debt $0 Common stock (=equity) $5,000,000 Total liabilities & equity $5,000,000 Income Statements EBIT $1,000,000 Interest expense $0 Taxable Income $1,000,000 Taxes (40%) 400,000 Net Income (=profit) 600,000 Total dollar return to investors $600,000 ROE 12.0%
Suppose that Seattle Health Plans use zero-debt financing. It's operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all equity financed, $5 million equity. The firm's profit, total dollar return to investors, and return on equity under these conditions are listed below. Suppose that the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent A) What impact would the new capital structure have on the firm's profit, total dollar return to investors, and return on equity? B) Redo the analysis, but now assume that the debt financing would cost 15 percent. C) Repeat the analysis required for question A, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Balance Sheets Total Assets $5,000,000 Debt $0 Common stock (=equity) $5,000,000 Total liabilities & equity $5,000,000 Income Statements EBIT $1,000,000 Interest expense $0 Taxable Income $1,000,000 Taxes (40%) 400,000 Net Income (=profit) 600,000 Total dollar return to investors $600,000 ROE 12.0%
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Suppose that Seattle Health Plans use zero-debt financing. It's operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all equity financed, $5 million equity. The firm's profit, total dollar return to investors, and
Suppose that the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent
A) What impact would the new capital structure have on the firm's profit, total dollar return to investors, and return on equity?
B) Redo the analysis, but now assume that the debt financing would cost 15 percent.
C) Repeat the analysis required for question A, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes.
| Total Assets | $5,000,000 |
| Debt | $0 |
| Common stock (=equity) | $5,000,000 |
| Total liabilities & equity | $5,000,000 |
| Income Statements | |
| EBIT | $1,000,000 |
| Interest expense | $0 |
| Taxable Income | $1,000,000 |
| Taxes (40%) | 400,000 |
| Net Income (=profit) | 600,000 |
| Total dollar return to investors | $600,000 |
| ROE | 12.0% |
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