Zheng Sen's Chinese Take-Out Had Earnings Before Interest and Taxes

question 131

Essay

Zheng Sen's Chinese Take-Out had earnings before interest and taxes of $4,000,000 last year. The firm has a marginal tax rate of 40 percent and currently has the following capital structure: (a) Calculate the firm's after-tax return on equity (ROE) and earnings per share (EPS).
(b) If the firm retires $4,000,000 of preferred stock using the proceeds from an equal increase in long-term debt, what would have been the after-tax return on equity (ROE) and earnings per share (EPS)?
(c) If the firm retires $4,000,000 of preferred stock using the proceeds from the sale of 500,000 shares of common stock, what would have been the after-tax return on equity (ROE) and earnings per share (EPS)?

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Definitions:

Forward Contract

A non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today.

Settlement Date

The date on which a trade or transaction must be finalized with the transfer of the asset and payment completed.

Risk Of Default

The possibility or likelihood that a borrower will not be able to meet debt obligations, leading to financial losses for the lender.

Futures Contracts

Financial contracts obligating the buyer to purchase an asset (like a commodity or financial instrument) and the seller to sell the asset at a predetermined future date and price.