Question

The Connecticut Computer Company has the selected financial results shown below.

	10% Debt	40% Debt	75% Debt
Debt	$8000
Equity	72000
Total Capital	$80000
Shares@ $5	14400
EBIT	$14400
Interest (15%)	1200
EBT	$13200
Tax (40%)	5280
Net Income	$7920
ROE
EPS

The company is considering a capital restructuring to increase leverage from its present level of 10% of capital.

1. Calculate Connecticut's ROE and EPS under its current capital structure.
2. Restate the financial statement line items shown, the number of shares outstanding, ROE, and EPS if Connecticut borrows money and uses it to retire stock until its capital structure is 40% debt assuming EBIT remains unchanged and the stock continues to sell at its book value. (Develop the second column of the chart shown.)
3. Recalculate the same figures assuming Connecticut continues to restructure until its capital structure is 75% debt. (Develop the third column of the chart.)
   Round ROE to one decimal place. Round EPS to two decimal places. Enter all amounts as positive numbers.

   	10% Debt	40% Debt	75% Debt
   Debt	$8000	$	$
   Equity	72000
   Total Capital	$80000	$	$
   Shares@ $5	14400
   EBIT	$14400
   Interest (15%)	1200
   EBT	$13200	$	$
   Tax (40%)	5280
   Net Income	$7920	$	$
   ROE	%	%	%
   EPS	$	$	$

4. How is increasing leverage affecting financial performance? What overall effect might the changes have on the market price of Connecticut’s stock? Why? (Words only. Hint: Consider the move from 10% to 40% and that from 40% to 75% separately.)
   

Answer 1