Table I

	Current	Proposed
Assets	5,000,000	5,000,000
Debt	0	2,500,000
Equity	5,000,000	2,500,000
Debt/Equity Ratio	0	1
Interest Rate	N/A	10%
Shares Outstanding	500,000	250000
Share Price	$10	$10

Question 2: Fill in the blank (Table II and Table III)

Based on the current and proposed capital structure, the company is conducting scenario analysis to determine some benchmark performance (EPS, ROE) of the company. Your job is to help managers making the capital structure decision by finishing the following two tables.

Table II Current Capital Structure:

	Recession	Expected	Expansion
EBIT	300,000	500,000	700,000
Interest
Net Income
EPS
ROE

Table III Proposed Capital Structure:

	Recession	Expected	Expansion
EBIT	300,000	500,000	700,000
Interest
Net Income
EPS
ROE

Question 3: Homemade Leverage

Based on the scenario analysis, the company's conservative management decide to maintain the current capital structure by not using leverage. However, the practice upsets a major prospective investor because he think the company is not acting in the interests of the shareholders. Even so, he is still interested in investing because in a world with no tax and perfect capital market, he can use homemade leverage by borrowing at 10%, the same interest rate offered to the company. Assume he is interested in buying 100,000 shares of the company's stock. How much should he borrow to replicate the ROE outcome under proposed capital structure? And show the expected outcome of using homemade leverage by finishing table IV.

a. How much should he borrow?

b. Fill in the blanks (Table IV)

	Recession	Expected	Expansion
EPS under unlevered firm
Net Income for 100,000 shares
Homemade leverage Interests
Net Profit
ROE