Adams Inc. expects EBIT of $50 million if there is a recession, $100 million if

Question

Adams Inc. expects EBIT of $50 million if there is a recession, $100 million if the economy is normal, and $150 million if the economy expands. Bellingham Inc. also expects EBIT of $50 million if there is a recession, $100 million if the economy is normal, and $150 million if the economy expands. Adams is financed entirely with equity while Bellingham is financed 50% with debt at 10%. Adams has $200 million in equity; Bellingham is financed with $100 million of debt and $100 million of equity. The tax rate is 30%. Both firms pay out all available earnings as dividends. If there is a recession, compare dividends and total distributions to investors for each company

Explanation / Answer

Adams Inc. Bellingham Inc. EBIT $                 50 $                           50 Less: Interest $                  -   $                           10 Profit before tax $                 50 $                           40 Less: Tax@30% $                 15 $                           12 Net income $                 35 $                           28 Dividends paid $                 35 $                           28 Total distribution to investors $                 35 $                           38 28+10

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