(Computing interest taxsavings) Presently, H.Swank, Inc. does not use any financial leverage and has total financing equal to$1.0 million. It is considering refinancing and issuing $500,000 of debt that pays 5.0percent interest and using that money to buy back half thefirm's common stock. Assume that the debt has a 30-year maturity such that Swank will have no principal payments for 30years. Swank currently pays all of its net income to common shareholders in the form of cash dividends and intends to continue this in the future. The corporate tax rate on thefirm's earnings is 35%. Swank's current income statement(before the debtissue) is shownhere:

Earnings before interest and taxes (EBIT)

100,000

Less: Interest expense

0

Equals: Earnings before taxes

100,000

Less: Taxes at 35%

(35,000)

Equals: Net income

65,000

a. If Swank issues the debt and uses it to buy back commonstock, how much money can the firm distribute to its stockholders and bondholders next year if thefirm's EBIT remains equal to

$100,000?

b. What areSwank's interest tax savings from the issuance of thedebt?

c. AreSwank's stockholders better off after the debtissue?

(Leverage andEPS) You have developed the following pro forma income statement for yourcorporation:

Sales

45,750,000

Variable costs

(22,800,000)

Revenue before fixed costs

22,950,000

Fixed costs

(9,200,000)

EBIT

13,750,000

Interest expense

(1,350,000)

Earnings before taxes

12,400,000

Taxes (50%)

(6,200,000)

Net income

6,200,000

It represents the most recentyear's operations, which ended yesterday. Your supervisor in thecontroller's office has just handed you a memorandum asking for written responses to the followingquestions:

a. If sales should increase by 25 percent, by what percent would earnings before interest and taxes and net incomeincrease?

b. If sales should decrease by 25 percent, by what percent would earnings before interest and taxes and net incomedecrease?

c. If the firm were to reduce its reliance on debt financing such that interest expense were cut inhalf, how would this affect your answers to parts a and b?