IO Corporation is comparing two different capital structures, a low-levered plan (Planl) and a high-levered plan (Plan 2), in two possible scenarios: Recession (EBIT S10 million), and Expansion (EBIT-$50 million) Capital Structure Debt Plan 2 Plan 1 Ss00 million Ss00 million $100 million S000 million Equity If the interest rate on debt is 5 percent annually and there are no corporate taxe9
a) What would the return on assets (ROA), the return on be in each Plan and scenario? equity (ROE), and the cost of equity (Rs)
b) Which plan will result in the higher business risk? Why? Define Business (Economic) risk and explain your answer referring to the Income Statement. Indicate 2 examples of sources of Business risk.
e) Represent graphically the return on the capital structure? How? Rank the financial risk of Plan 1 and Plan 2, In the Recession scenario, which of the two plans will be better for the company? And In case of Expansion?
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