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2. Company ABC is currently an unlevered company with a firm value of $540,000. Its current earnings in EBIT amounts to $61,000. Total share outstanding
2. Company ABC is currently an unlevered company with a firm value of $540,000. Its current earnings in EBIT amounts to $61,000. Total share outstanding equals 10,000. The company is considering changing to a new capital structure by raising $270,000 debt capital and use the capital raised to perform a share buyback so that the firm will have $270,000 in equity (i.e., D/E = 1). The cost of debt capital is 8%. Assume that the company will payout all its earnings to shareholders and that it operates in a zero taxes world. (a) What is the return on equity under the current (ZERO debt) structure? (b) What is the return on equity under the proposed structure (D/E =1)? (c) Suppose you have $54 personal wealth. How can you use homemade leverage to construct the return pattern similar to the return pattern under proposed (D/E = 1) capital structure
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