Intermediate Financial Management (MindTap Course List)
12th Edition
ISBN: 9781285850030
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 16, Problem 3MC
d)
1)
Summary Introduction
Case summary:
Company P is a regional pizza restaurant chain. The given details are as follows,
EBIT is $50 million,
Tax rate is 40%,
Risk-free
Market risk premium is 6%,
Outstanding shares 10 million.
As of now company is financed with equity only, there is no debt. Now, the company wanted to raise capital by using some debt. When the company were to recapitalize, then debt would be issued, and funds received would be used as repurchase stock.
To construct: Partial income statements which start from EBIT.
2)
Summary Introduction
To calculate:
3)
Summary Introduction
To discuss: Impact of this example on financial leverage on ROE.
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Now, to develop an example that can be presented to PizzaPalace’s management to illustratethe effects of financial leverage, consider twohypothetical firms: Firm U, which uses no debtfinancing, and Firm L, which uses $10,000 of 12%debt. Both firms have $20,000 in assets, a 40%tax rate, and an expected EBIT of $3,000.
To illustrate the effects of financial leverage for PizzaPalace’s management, consider two hypothetical firms: Firm U (which uses no debt financing) and Firm L (which uses $4,000 of 8% interest rate debt). Both firms have $20,000 in net operating capital, a 25% tax rate, and an expected EBIT of $2,400.
(1) Construct partial income statements, which start with EBIT, for the two firms.
(2) Calculate NOPAT, ROIC, and ROE for both firms.
(3) What does this example illustrate about the impact of financial leverage on ROE?
(4) Why did leverage increase ROE in this example?
There are two firms in the same business: Air Wolf and Red Wolf. Both are in the same risk class, and each has an EBIT (Earnings Before Interest & Taxes) of $10 million. Air Wolf has no debt and Red Wolf has $4 million of debt. The cost of equity is 8% and the cost of debt is 10%. Assume a tax rate of 30%. Calculate the: (a) total value of each firm and (b) the breakdown of value or capital structure in terms of its components (debt & equity).
Chapter 16 Solutions
Intermediate Financial Management (MindTap Course List)
Ch. 16 - Prob. 1QCh. 16 - Prob. 2QCh. 16 - Prob. 3QCh. 16 - One type of leverage affects both EBIT and EPS....Ch. 16 - Prob. 5QCh. 16 - Prob. 6QCh. 16 - Prob. 7QCh. 16 - Prob. 8QCh. 16 - Prob. 9QCh. 16 - Prob. 1P
Ch. 16 - Unlevered Beta
Counts Accounting’s beta is 1.15...Ch. 16 - Premium for Financial Risk
Ethier Enterprise has...Ch. 16 - Value of Equity after Recapitalization Nichols...Ch. 16 - Stock Price after Recapitalization Lee...Ch. 16 - Prob. 6PCh. 16 - Prob. 7PCh. 16 - Capital Structure Analysis Pettit Printing Company...Ch. 16 - Optimal Capital Structure with Hamada
Beckman...Ch. 16 - WACC and Optimal Capital Structure F. Pierce...Ch. 16 - Prob. 12PCh. 16 - Prob. 1MCCh. 16 - Prob. 2MCCh. 16 - Prob. 3MCCh. 16 - Prob. 4MCCh. 16 - Prob. 5MCCh. 16 - Prob. 6MCCh. 16 - What does the empirical evidence say about capital...
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