The Connecticut Computer Company has the selected financial results shown below.

Question

The Connecticut Computer Company has the selected financial results shown below.

The company is considering a capital restructuring to increase leverage from its present level of 20% of capital.

a. Calculate Connecticut's ROE and EPS under its current capital structure.

b. Restate the financial statement line items shown, the number of shares outstanding, ROE, and EPS if Connecticut borrows money and uses it to retire stock until its capital structure is 40% debt assuming EBIT remains unchanged and the stock continues to sell at its book value. (Develop the second column of the chart shown.)

c. Recalculate the same figures assuming Connecticut continues to restructure until its capital structure is 75% debt. (Develop the third column of the chart.)
Round ROE to one decimal place. Round EPS to two decimal places. Enter all amounts as positive numbers.

20% Debt 40% Debt 75% Debt Debt $24,000 Equity 96,000 Total Capital $120,000 Shares@ $5 19,200 EBIT $19,200 Interest (15%) 3,600 EBT $15,600 Tax (40%) 6,240 Net Income $9,360 ROE EPS

Explanation / Answer

1) At 20% debt level, ROE= Net icnome/equity

= 9360/96000 = 0.0975

EPS= net icnome/ no of shares= 9360/19200

= 0.4875

2) At 40% debt, the debt is = 48000

hence, equity = 72000

No of shares outstanding = 72000/5

= 14400

Interest at 15%= 0.15*48000= 7200

EBT = 19200-7200

= 12000

Net income= 0.6*12000

=7200

ROE= 7200/72000

= 0.1

EPS= 7200/14400

= 0.5

3) For, at 75% debt level, debt = 90000 and equity = 30000

No of shares = 30000/5 = 6000

rest calculation are similar to above two debt level

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