1. Assume Armstrong Production has 110 m debt in its capital structure. It has 15 million shares of stock trading at $22 per share. Assume Armstrong decides to introduce $200 million in debt and the cost of debt would be 11% and decides to buy back at the existing price of $22. If restructuring is expected to increase the earnings per share, what is the minimum level for EBIT that the management must be expecting? Ignore taxes while answering. Would there be an advantage to debt financing if the actual EBIT was greater than the breakeven point? Explain?
2. Assume that Armstrong has only two capitalization alternatives An all equity capital structure with $400 million of stock or $200 million of 11% debt plus 200 million of equity. Calculate the ROE and TIE for each alternative at each EBIT level. Discuss the risk return tradeoff under the two financing alternatives. In your discussion, consider the expected ROE and the standard deviation of ROE under each alternative.