CASE 4 (25 points)

Alabama Corporation has 10,000,000 of assets. Currently, it is an all-equity financed and has 500,000 shares. Proposed capital structure is 50% of debt and 50% of equity, with the same amount of assets. Interest rate on debt is 10%. Expected level of EBIT is 2,000,000.

Instructions:

1. Ignoring taxes, calculate EPS and ROE for the current and proposed capital structures. (10 points)

2. Repeat part (1) assuming that the corporate tax rate is 25 percent. (10 points) 3. Explain the effect of financial leverage. (5 points)