Seattle Health Plans currently use zero-debt financing. It's operating income (EBIT) is $1 million, and it pays taxes at a 40% rate. It had $5 million in assests, 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%
C. Return to the initial 8% interest rate. Now assume that EBIT could be as low as %500,000 or as high as $1.5 million. There remain a 60% chance that EBIT would be $1 million.
D. Repeat the analysis required for part a, but now assume that Seattle Health Plan is a not-for-profit corporation and pays no taxes. Compare the results with those obtained in Part a.