Response to the following problem:
The Chew-Z Corporation is considering three possible financing arrangements to raise $10,000 of new capital. Currently, the capital structure of Chew-Z consists of no debt and $10,000 of equity. There are 500 shares of common stock currently outstanding, selling at $20 per share. The Chew-Z is expected to generate $12,000 of earnings before interest and taxes next period. It is expected that the interest rate on any debt would be 10%. The three possible financing alternatives are:
Alternative 1: Finance completely with new equity.
Alternative 2: Finance using 50% debt and 50% new equity.
Alternative 3: Finance completely with new debt.
a. Calculate the following items for each alternative, assuming that there are no taxes on corporate income:
¦ Earnings to owners
¦ Earnings per share
¦ Distribution of income between creditors and shareholders
b. Calculate the following items for each alternative, assuming that the marginal rate of tax on corporate income is 40%:
¦ Earnings to owners
¦ Earnings per share
¦ Distribution of income among creditors, shareholders, and the government