Question
Appliances, Inc. has no debt outstanding, and its financial position is given by the following data: Assets (market value = book value) $5,000,000 EBIT $800,000
Appliances, Inc. has no debt outstanding, and its financial position is given by the following data:
Assets (market value = book value) | $5,000,000 | |
EBIT | $800,000 | |
Cost of equity | 12% | |
Stock price | $10 | |
Shares outstanding | 500,000 | |
Tax rate | 25% |
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 20% debt based on market values, its cost of equity will increase to 13% to reflect the increased risk. Bonds can be sold at a cost of 6%. Appliance, Inc. is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.
As a creditor, you are concerned about the companys ability to repay its debt and interest. What is the new times interest earned?
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