Firm ZZZ currently is all-equity financed. It has 10,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $200,000 with the proceeds used to buy back stock. The high-debt plan would call for a debt issue of $400,000 with the proceeds used to buy back stock. The debt will pay an interest rate of 10%. The firm pays no taxes.

1. What will be the debt-to-equity ratio if ZZZ borrows $200,000? [6 marks]

2. If earnings before interest and tax (EBIT) are $110,000, what will be earnings per share (EPS) if ZZZ borrows $200,000? [6 marks]

3. What will EPS be if ZZZ borrows $400,000? [6 marks]

Firm ZZZ would like to learn more about financial distress.

4. For which of the following firms would you expect the costs of financial distress to be highest? Briefly explain. [7 marks]

• A computer software company that depends on skilled programmers to produce new products.

• A shipping company that operates a fleet of modern tankers.