Pizza Palace
Percent Financed with Debt, (wd)	Cost of Debt, (rd)
0%	----
20%	8.0%
30%	8.5%
40%	10.0%
50%	12.0%
Partial Income Statement	Firm U	Firm L
EBIT
Interest
EBT
Taxes
Net Income
EBIT
NOPAT
Operating capital	$20,000	$20,000
ROIC
Equity	$20,000	$20,000
Net Income
ROE

Assume your team has just been hired as business consultants of Pizza Palace, a regional pizza restaurant chain. The companys EBIT was $230 million last year and is not expected to grow. Pizza Palace is in the 25% state-plus-federal tax bracket, the risk-free rate is 6 percent, and the market risk premium is 6 percent. The firm is currently financed with all equity, and it has 10 million shares outstanding.

You know from experience that most firms owners are financially better off if the firm uses some debt. When you suggested this to the owner, he encouraged you to pursue the idea. If the company were to recapitalize, then debt would be issued, and the funds received would be used to repurchase stock. As a first step, assume that you obtained from the firms investment banker the estimated costs of debt for the firm at different capital structures.

Use the information within chapter 15 to help answer the following questions:

4.) Explain the difference between financial risk and business risk.