DISCUSSION QUESTION 5-2
MF620: Financial Statement Development and Analysis

Lesson 5: Financing and Capital Structure


Upon completion of the Required Readings, write a thorough, well-planned narrative answer to the following discussion question. Rely on your Required Readings and the Lecture and Research Update for specific information to answer the discussion question, but turn to your original thoughts when asked to apply, evaluate, analyze, or synthesize the information. Your Discussion Question response should be both grammatically and mechanically correct, and formatted in the same fashion as the question itself. If there is a Part A, your response should identify a Part A, etc. In addition, you must appropriately cite all resources used in your responses and document in a bibliography using APA style.

Discussion Question 2 (50 points)
Respond to the following:

1. Assume that a firm’s earnings per share (EPS) are expected to be $2.00 next year and that analysts have determined that an appropriate forward-looking multiple is 15 times the projected earnings. What should the stock price be?

2. Suppose that the firm in question #1 plans to increase the proportion of debt as part of its capital structure. The projected EPS would then be $2.50. In a world with no financial distress, determine what the stock price should be and explain why in the real world the stock price would be less than that amount.

3. Calculate an EBIT breakeven between a debt firm (DF) and an all-equity firm (EF) based on the following information: DF interest = $40,000; DF number common shares = 6,000; EF number of common shares = 10,000; and tax rate = 35 percent. Check your answer by calculating the EPS for both DF and EF at the breakeven EBIT.

4. Calculate the cash flow coverage ratio based on the following information: EBIT = $540,000; depreciation and amortization = $65,000; interest payments = $180,000; principal repayment = $75,000; and tax rate = 35 percent.

5. Suppose a firm has an EBIT of $5 million, interest expenses of $2 million, depreciation expenses of $1 million, and a tax rate of 35 percent. Its bank agrees to lend up to 4 times its EBITDA. How much debt can the firm borrow from the bank?

6. Suppose an all-equity firm has a beta estimated to be 1.2. If the firm changes its capital structure such that its debt-to-equity ratio is now 0.4, what should be the revised beta estimate if it also faces a tax rate of 35 percent?

ANSWER WILL BE SENT ON EMAIL.