Assignment $5\mathrm{.}4$ Exercises $0$

Problem $7$: Impact of Financial Leverage $5$ Points

Behemoth Enterprises needs to raise $$10$ Billion to fund a major new project designed to reinvigorate the giant company's growth. The company's top executives are debating whether to raise the money by issuing debt or by issuing new shares of stock. Their team of analysts predict that if the project goes through, the company's Earnings Before Interest and Taxes $($EBIT$)$ will increase to $$9\mathrm{.}7$ Billion. However, if the company uses debt to fund the project, they will have to pay interest of $5\%$ on this new debt, along with $$200$ million in annual sinking fund payments. This would be on top of the $$2\mathrm{.}75$ Billion the company already pays in interest on its existing debt, plus $$2\mathrm{.}3$ Billion in annual sinking fund payments. If the company instead chooses to issue new shares of stock, their investment banker predicts they will be able to issue additional shares at $$10$ per share. The company currently has $8\mathrm{.}7$ Billion shares outstanding at $$11\mathrm{.}50$ per share. The company's effective tax rate is $21\%.$

a$)$ If the company raises the funding with equity, what will be its times$-$interested earned ratio? What will be its times$-$burden$-$covered ratio? What will be its earnings per share?

b$)$ If the company raises the funding with debt, what will be its times$-$interested earned ratio? What will be its times$-$burden$-$covered ratio? What will be its earnings per share?

Use the Template Provided Below to Create Your Solution $-$ Pay close attention to the formulas and formatting of the inputs.

Input area:

Expected EBIT After Project $($$ millions$)$

Funding Needed $($$ millions$)$

Annual Interest on Existing Debt $($$ millions$)$

Interest Rate on New Debt $(\%)$

Sinking Fund Payments on Existing Debt $($$ millions$)$

Sinking Fund Payment on New Debt $($$ millions$)$

Common Stock Price $($$ per share$)$

Price of New Issue of Stock $($$ per share$)$

Common Shares Outstanding $($millions$)$

Effective Tax Rate $(\%)$