c$.$ The $$500,000$ EBIT given previously is actually the expected value from the following probability distribution:

Determine the times$-$interest$-$eamed ratio for each probability. What is the probability of not covering the interest payment at the $40\%$ debt level?

Probability $=$

$\%$Problem $12-12$

Capital Structure Analysis

Hagen Horticulture and Supplies Limited has no debt outstanding, and its financial position is given by the following data:

The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with $40\%$ debt based on

market values, its cost of equity, $r_3,$ will increase to $9\mathrm{.}57\%$ to reflect the increased risk. Bonds can be sold at a cost, $r_a,$ of $7\%.$ Hagen is a no$-$growth

firm. Hence, all its earnings are paid out as dividends, and earnings are expected to be constant over time.

a$.$ What effect would this use of leverage have on the value of the firm?

The value of the firm would

b$.$ What would be the market value of Hagen's equity?

Market value of equity $=5$