Question

Seattle Health Plans currently uses zero-debt financing. Its operating income (EBIT) is $1M, and pays 40% tax rate. It has $5M in assets (& equity). Suppose the firm is considering replacing half of its equity financing with debt @ 15%.

a. What impact would this have on NI,ROI,ROE?

c. What if SHP is a NFP?

Answer 1

Solution - SET L£ HEALTH PLC : current EBIT = $1,000,000 Tax Rate - 4044. Total Asset = $5,000,000 The firm is all equity ,so, Total Equity = $5,000,000 (9) Now, the firm plans to replace half of its equity finanung with debt @ 15%. So, there will be $2,500,000 as debt and equity each. Equity financing | Debt-Equity Financing - 1,000,000 EBIT less: Interest you Taxable income less: Tax (40%) Net Income $ 1,000,000 (375,000) 6 25,000 1,000,000 (400,000) $ 600,000 (50,000) 375,000 ROE = Net Income - Equity $ 600,000 $5,000,000 = 0.12 or 12% $375,000 $2,500,000 = 0.15 og 154

Roi Net Income Total Investment $600,000 $ 5000,000 = 0.12 or 12. $ 375,000 $5,000,000 = 0.075 or 7.54. 1 that of return on - 1. As we can see that when debt is introduced in capital structure by replacing the half of equity, 1) the net income decreases because interest rate on debt was more than equity in equity financing the return on equity increases as the value of equity is less in debt-equity mix , (11) Return on investment is also less in debt equity financing mix , as, the net income is less in debt - equity financing mix. Notes? © Since there is no debt in equity finanuing there will be no interest. ☺ Interest on debt of $2,500,000 is calculated as follows 160 x $ 2,500,000 = $3750 00

(C) of SHP ( seattle Health Plans) is not for Profit (NFP) organisation, then it will be tax exempt that means it will not have to pay taxes. Now, we will calculate NI, ROI and Roe as if she is Not for Profit organisation. | Equity Financing | Debt-Equity fina neing EBIT $1,000,000 $ 1000,000 Less: Interest $ 375,000 Net Income $ 1,000,000 $ 625,000 ROE = = Net Income Equity $1,000,000 $5,000,000 20.20 00 20% $ 625,000 $2,500,000 = 0.25 or 254. ROI = Net Income Total Investment ,000 $5,000,000 = 0.20 07 2044 $ 695,000 $5.900,000 = 0.125 0x 19.501.