XYZ, Inc., a biotech company. XYZ, Inc. has expected annual EBIT of $1,500,000 in perpetuity and the appropriate discount rate for cash flow risk is 15%. XYZ is a capital company and has 500,000 shares outstanding. The CEO of XYZ, Inc. has an exciting plan to make her company seem more attractive to her company. She suggests to her CFO that if the company issues $5 million debt in perpetuity with a 10% yield and uses this debt to buy back some of the company's stock, it will make the company more attractive to investors. buyers. The CFO is skeptical of the CEO's plan and argues with her about the logic behind it. Frustrated with her CFO's argumentative stance, the CEO eventually simply says, “I don't have to convince you, John, especially since my plan is foolproof. My debt-based strategy will make our company attractive to any acquirer because it will lower our price-earnings ratio and consequently cause them to offer us much more money for our assets than they otherwise would." She assumes that the corporate tax rate is 35% and that interest payments on the debt are tax deductible.

Q16. Is the CEO correct in believing that XYZ, Inc.'s price-earnings ratio will decline?

Q17. What will the new P/E ratio of XYZ, Inc. be if it adopts this new, enhanced debt strategy?

Q18. Is the CEO correct in concluding that his company will pay more to acquire XYZ, Inc.?

Q19. What is the new business value of XYZ, Inc.?

Q20. What is XYZ, Inc.'s return on equity if the CEO's proposal to borrow is implemented?

Answer rating: 100% (QA)

Q16 Is the CEO correct in believing that XYZ Incs priceearnings ratio will decline The CEO is correct in believing that XYZ Incs priceearnings PE rati... View the full answer