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Seattle Health Plans currently uses zero debt financing. Its operating income (EBIT) $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 in equity. Suppose the firm is considering replacing half of its equity financing with debt financing bearing an interest rate of 8 percent.

a. What impact would the new capital structure have on the firm’s net income, total dollar return to investors, and ROE?

b. Redo the analysis, but now assume the debt financing would cost 15 percent?

c. Repeat the analysis required for Part a, but now assume the Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Compare the results with those obtained in Part a.

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M93053128

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