Problem: Starsburg electronics has never used debt, but the treasurer is considering a possible change in the capital structure. For now, assume that only two financing options are being considered for a firm that currently has $200,000 in total assets remaining at zero percent debt (i.e. $200,000 equity) or shifting to $100,000 debt and $100,000 equity. The tax rate for the firm is 40% and interest rate on debt is 10%
(1) Complete the missing data in the tables below.
(2) As a treasurer, what conclusions or capital structure policies can you draw from these tables?
Option I: No debt ($200,000 equity)
|
|
Recession
|
Strong Economy
|
|
EBIT
|
-$60,000
|
$140,000
|
|
Less: Interest (12%)
|
|
|
|
=EBT
|
|
|
|
Less: Taxes (40%)
|
|
|
|
=EAT or Net income
|
|
|
|
|
|
|
|
ROE=EAT/Total equity
|
|
|
Option II: 50% debt ($100,000 equity and $100,000 debt at 10% interest rate)
|
|
Recession
|
Strong Economy
|
|
EBIT
|
-$60,000
|
$140,000
|
|
Less: Interest (12%)
|
|
|
|
=EBT
|
|
|
|
Less: Taxes (40%)
|
|
|
|
=EAT or Net income
|
|
|
|
|
|
|
|
ROE =EAT/Total equity
|
|
|