Watson Waterbed Works Inc. has an EBIT of $2.75 million, can borrow at 15% interest, and pays

Question:

Watson Waterbed Works Inc. has an EBIT of $2.75 million, can borrow at 15% interest, and pays combined state and federal income taxes of 40%. It currently has no debt and is capitalized by equity of $12 million. The firm has 1.5 million shares of outstanding that trade at book value.
a. Calculate Watson’s EAT, ROE, and EPS currently and at capital structures that have 20%, 40%, 60%, and 80% debt.
b. Compare the EPS at the different leverage levels, and the amount of change between levels as leverage increases. What happens to the effect of more debt as leverage increases from a little to a lot?

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...