A Firm Is Analyzing Two Different Capital Structures for Financing

question 21

Multiple Choice

A firm is analyzing two different capital structures for financing a new asset that will cost $100,000.The effects of the two structures on the firm's balance sheet are described below.
Plan A: finance with 50% debt
New asset $100,000 Debt $50,000
Common equity $50,000
Total $100,000
Plan B: finance with 70% debt
New asset $100,000 Debt $70,000
Common equity $30,000
Total $100,000
Based on the information provided,we can conclude that

• A)if the firm chooses Plan A,then any changes in the firm's EBIT will lead to larger fluctuations in the firm's EPS than if the firm chooses Plan B.
• B)if the firm chooses Plan B,then any changes in the firm's EBIT will lead to larger fluctuations in the firm's EPS than if the firm chooses Plan A.
• C)if the firm chooses Plan A,then any changes in the firm's EBIT will lead to the same fluctuations in the firm's EPS as will occur if the firm chooses Plan B.
• D)if the firm chooses Plan B,then any changes in the firm's EBIT will lead to smaller fluctuations in the firm's EPS than if the firm chooses Plan A.

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Definitions:

Loan

A sum of money that is borrowed, typically from a financial institution, which is expected to be paid back with interest.

Lease

A contractual agreement in which one party (the lessor) allows another (the lessee) to use an asset for a specified period of time in exchange for payment or some other consideration.

Lessor

A lessor is a person or entity who leases or rents property to another, known as the lessee.

Tenant

An individual who rents or leases a space, such as an apartment or office, from a landlord.