Question: XYZ Corp is comparing two different capital structures. Under Plan I, the company has no debt and has 100,000 shares of stock outstanding selling at

XYZ Corp is comparing two different capital structures. Under Plan I, the company has no debt and has 100,000 shares of stock outstanding selling at a price of $20 per share. Under Plan II, the company will convert 40,000 shares of stock outstanding to debt at an interest rate of 10%. Assume that there are no taxes.

a. If EBIT is $100,000, which plan will result in higher ROE?

b. If EBIT is $800,000, which plan will result in higher ROE?

c. What can you conclude from the values of ROE obtained in a. and b.?

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