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Seattle Health Plans currently uses zero-debt financing
Seattle Health Plans currently uses zero-debt financing. Its operating income (earnings before interest and taxes, or EBIT) is $1 million, and it pays taxes at a 30 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 return on equity (ROE)?
b. Redo the analysis, but now assume that the debt financing would cost 15 percent?
Expert Solution
As we can see that after new capital structure Net income will decrease and ROE will increase.
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