The four alternatives considered explicitly in the case are 1. Maintain existing financial policy with no debt;
Question:
The four alternatives considered explicitly in the case are
1. Maintain existing financial policy with no debt;
2. Borrow $23 million (10% debt to total book capital);
3. Borrow $45 million (20% debt to total book capital);
4. Borrow $68 million (30% debt to total book capital).
Using the scenarios in case Exhibit 32.9, what role does leverage play in affecting the return on equity (ROE) for CPK? If the EBIT line is multiplied by a factor of 1.5, how will be the effect of leverage on the risk of equity returns different, compared to the base case? If the EBIT line is multiplied by a factor of 0.5,
how will be the effect of the risk of equity returns different, compared to the base case?
California Pizza Kitchen
Pro Forma Tax Shield Effect of Recapitalization Scenarios
(dollars in thousands, except share data; figures based on end of June 2007)
Debt/Total Capital | ||||
Actual | 10% | 20% | 30% | |
Interest rate | 6.16% | 6.16% | 6.16% | 6.16% |
Tax rate | 32.5% | 32.5% | 32.5% | 32.5% |
Earnings before income taxes and interest | 30,054 | 30,054 | 30,054 | 30,054 |
Interest expense | 0 | 1,391 | 2,783 | 4,174 |
Earnings before taxes | 30,054 | 28,663 | 27,271 | 25,880 |
Income taxes | 9,755 | 9,303 | 8,852 | 8,400 |
Net income | 20,299 | 19,359 | 18,419 | 17,480 |
Book value: | ||||
Debt | 0 | 22,589 | 45,178 | 67,766 |
Equity | 225,888 | 203,299 | 180,710 | 158,122 |
Total capital | 225,888 | 225,888 | 225,888 | 225,888 |
Return on equity |
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill