Barette Consulting Currently Has No Debt in Its Capital Structure

question 34

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:

Borrowing Rate

The interest rate that a lender charges a borrower for the loan of funds, varying based on credit risk, loan amount, and duration.

Net 60

A payment term indicating that payment is due 60 days after the invoice date.

Lock Box System

A banking service provided to companies for speeding up collection of payments by having those payments sent directly to a bank's PO box, rather than to the company.

Clearing Time

The period between the initiation of a transaction and its settlement, during which the transaction is processed and validated.