The Connecticut Computer Company has the following selected financial results:

10% Debt 40% Debt 75% Debt

Debt $ 10,000

Equity 90,000

Total capital $100,000

Shares (@ $5) 18,000

EBIT $ 18,000

Interest (15%) 1,500

EBT $ 16,500

Tax (40%) 6,600

Net income $ 9,900

ROE

EPS

The company is considering a capital restructuring to increase leverage from its present level of 10% of capital.

a. Calculate Connecticuts ROE and EPS under its current capital structure.

b. Restate the financial statement line items shown, the number of shares outstanding, ROE, and EPS if Connecticut borrows money and uses it to retire stock until its capital structure is 40% debt assuming EBIT remains unchanged and the stock continues to sell at its book value. (Develop the second column of the chart shown.)

c. Recalculate the same figures assuming Connecticut continues to restructure until its capital structure is 75% debt. (Develop the third column of the chart.)

d. How is increasing leverage affecting financial performance? What overall effect might the changes have on the market price of Connecticuts stock? Why? (Words only. Hint: Consider the move from 10% to 40% and that from 40% to 75% separately.)