Seattle Health Plans currently uses zero-debt financing. Its operating income (EBIT) is $1 million, and it pays taxes at a 40% 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 %.
a. What impact would the new capital structure have on the firm’s net income, total dollar return to investors, and ROE?
b- Redo the analysis, but now assume that the debt financing would cost 15 percent
c- Report the analysis required for part a , but now assume that Seattle health plan is a not for profit corporation and hence pays no taxes . Compare the results with those obtained in part a