Capital Structure Analysis

The Rivoli Company has no debt outstanding, and its financial position is given by the following data:

Assets (Market value = book value)	$3,000,000
EBIT	$500,000
Cost of equity, rs	10%
Stock price, Po	$15
Shares outstanding, no	200,000
Tax rate, T (federal-plus-state)	40%

The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 40% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 6%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.

1. The $500,000 EBIT given previously is actually the expected value from the following probability distribution:

Probability	EBIT
0.10	($ 100,000)
0.20	150,000
0.40	550,000
0.20	750,000
0.10	1,100,000

2. Determine the times-interest-earned ratio for each probability. Use a minus sign to enter negative values, if any. Do not round intermediate calculations. Round your answers to two decimal places.

Probability	TIE
0.10
0.20
0.40
0.20
0.10

3. What is the probability of not covering the interest payment at the 40% debt level? Do not round intermediate calculations. Round your answer to two decimal places. %