Fill in the table using the following information: Assets required for operation

Question

Fill in the table using the following information:
Assets required for operation: $10,000
Firm A uses only equity financing
Firm B uses 30% debt with a 6% interest rate and 70% equity
Firm C uses 50% debt with a 10% interest rate and 50% equity
Firm D uses 50% preferred stock financing with a dividend rate of 10% and 50% equity financing
Earnings before interest and taxes: $1,000

Table:

A B C D
Debt $ $ $ $
Preferred stock
Common stock
Earnings before interest and taxes
Interest Expense
Earnings before taxes
Taxes (40% of earnings)
Preferred stock dividends
Net earnings
Return on common stock

Also answer the following questions:
What happens to the return on the stockholders' investment as the amount of debt increases? Why is the rate of interest greater in case C? Why is the return lower when the firm uses preferred stock instead of debt? Why does the use of preferred stock involve less risk for the firm than a comparable use of debt financing?

Explanation / Answer

A B C D

debt 0 3000 5000 0

Preffered stock 0 0 0 5000

common stock 10000 7000 5000 5000

EBIT 1000 1000 1000 1000

interest exp 0 180 500 0

earnings before 1000 820 500 1000

taxes

taxes 400 328 200 400

net earnings 600 492 300 600

Return on common 6% 7% 6% 2%

stock

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