Seattle health plans currently uses zero debt financing. Its operating income 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 firms profit, total dollar return to investors, and return on equity?

b.) Redo the analysis, but now assume that the debt financing would cost 15 percent.

c.) Repeat the analysis required for Part a, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Compare the results with those obtained in Part a.

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