Barette Consulting Currently Has No Debt in Its Capital Structure,has

question 27

Multiple Choice

Barette Consulting currently has no debt in its capital structure,has $500 million of total assets,and its basic earning power is 15%.The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock,paying book value.If the company proceeds with the recapitalization,its operating income,total assets,and tax rate will remain unchanged.Which of the following is most likely to occur as a result of the recapitalization?

• A) The ROA would remain unchanged.
• B) The basic earning power ratio would decline.
• C) The basic earning power ratio would increase.
• D) The ROE would increase.
• E) The ROA would increase.

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Definitions:

Dividends

Payments made by a corporation to its shareholders, representing a portion of the company's earnings.

Net Capital Gain

The profit from the sale of an investment or property, calculated as the difference between the sale price and the original purchase price after adjusting for various factors such as brokerage fees, taxes, and improvements.

Preferential Tax Rates

Lower tax rates applied to certain types of income, such as long-term capital gains and qualified dividends, compared to ordinary income tax rates.

Corporation

A legal entity owned by shareholders with rights and responsibilities distinct from those of its owners, recognized by law as a single entity.