A company has assets of $350,000, annual EBIT of $100,000, and a tax rate of 40%. It can borrow at an interest rate of 8%.
In Excel create a table where each row corresponds to a different amount that the company might borrow: $0, $50000, $100000, $150000, $200000, $250000. For each level of debt calculate the following:
Tax shield, new value of the company, new value of equity, debt to equity ratio, interest paid, earnings before taxes, tax paid, net income, return on equity using the definition, return on equity using M&M proposition II with taxes. Note that the last two should be equal.
Create a chart which shows the relationship between the debt to equity ratio (horizontal axis) and the return on equity (vertical axis).