BUSINESS FINANCING AND THE COST OF CAPITAL

Running head: BUSINESS FINANCING AND THE COST OF CAPITAL 1




BUSINESS FINANCING AND THE COST OF CAPITAL

Name

Institutional Affiliation

Course

Instructor’s name

Date

, BUSINESS FINANCING AND THE COST OF CAPITAL 2




8.1 Solution.

a.

As according to the given values we have,

Equity = $2500000

8 percent Debt = $2500000

Interest on debt = $2500000 x 8 percent

Interest on debt = $ 200000

Taxable Income is going to drop by $ 200000.

The formula used here is,

Earnings before Taxes = Given Operating Profit – The paid interest

Earnings before Taxes = $(1000000 - 200000)

Earnings before Taxes = $ 800000

Earnings after cutting taxes (Net Income) = $800000 x (1 - 0.40)

Earnings after taxes (Net Income) = $480000

Net profit has reduced by $120000 (0.60 - 0.48)

Here we will use,

Return on total equity = (Net profit / Employed equity) x 100

Return on equity = $480000 / $2500000x 100 = 19.2 percent

b.

15 percent debt, Interest paid = 15% x $2500000

15% percent, Interest paid = $380000

Revised Earning before taxes = $1000000 - $380000

Revised Earning before taxes = $620000