Advanced Managerial Finance Mini Case - 2153 Words

------------------------------------------------------------------------------------------------------------------------------------------ Assume you have just been hired as a business manager of PizzaPalace, a regional pizza restaurant chain. The company s EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm s investment banker the following†¦show more content†¦(1) Construct partial income statements, which start with EBIT, for the two firms. Firm U Firm L Assets $20,000 $20,000 Equity $20,000 $10,000 EBIT $ 3,000 $ 3,000 INT (12%) 0 1,200 EBT $ 3,000 $ 1,800 Taxes (40%) 1,200 720 NI $ 1,800 $ 1,080 (2) Now calculate ROE for both firms. Firm U Firm L BEP 15.0% 15.0% ROI 9.0% 11.4% ROE 9.0% 10.8% TIE 2.5 (3) What does this example illustrate about the impact of financial leverage on ROE? Firm L has higher expected ROI because of the tax savings effect. Firm L also has the higher expected ROE resulted in part from the tax savings. The use of financial leverage has increased the expected profitability to shareholders. Stock is riskier if the firm uses debt. The use of debt will increase ROE only if ROA exceeds the after-tax cost of debt. D. Explain the difference between financial risk and business risk. Business risk increases the uncertainty in future EBIT. It depends on business factors such as competition, operating leverage, etc. Financial risk is the additional business risk concentrated on common stockholders when financial leverage is used. It depends on the amount of debt and preferred stock financing. E. What happens to ROE for Firm U and Firm L if EBIT falls to $2,000? What does this imply about the impact of leverage on risk andShow MoreRelatedMini Case - Mckenzie Corporations Capital Budgeting942 Words   |  4 PagesCFEA3230 Advanced Managerial Finance individual assignment: MINI CASE - McKENZIE CORPORATIONS CAPITAL BUDGETING Prepared by :- RUBBIATUN ARDAWIYAH bt ABDUL HAMID CEA 080147 Prepared for:- Profesor Madya Dr. Rubi Binti Ahmad Date of submission :- 25 april 2012 MINI CASE - McKENZIE CORPORATIONS CAPITAL BUDGETING Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company. 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