A Firm Faces a 21 Percent Tax Rate and Has

question 48

Multiple Choice

A firm faces a 21 percent tax rate and has $500m in assets, currently financed entirely with equity. Equity is worth $100 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $70m. The firm is considering switching to an 18 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt. How much will ROE change if they switch to the proposed capital structure?

• A) There will be no change in the firm's ROE.
• B) The ROE will decrease by 0.52 percent.
• C) The ROE will increase by 1.58 percent.
• D) The ROE will increase by 1.04 percent.

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Definitions:

Population

The total number of people inhabiting a particular country, area, or place, often analyzed for demographic purposes.

Cotton Gin

A machine invented by Eli Whitney in 1793 that quickly and efficiently removes cotton seeds from cotton fibers, greatly impacting the cotton industry and slavery in the United States.

Atlantic Slave Trade

The transatlantic trading patterns which were established from the 16th through the 19th centuries, which transported millions of Africans to the Americas as slaves.