Buddy Inc. has $6 million in assets, $700,000 EBIT, 80,000 shares

QUESTION

Buddy Inc. has $6 million in assets, $700,000 EBIT, 80,000 shares of stock outstanding, and a marginal tax rate equal to 40 percent. If Buddys debt-to-total-assets ratio (D/TA) is 70 percent, it pays 12 percent interest on debt, whereas if the D/TA ratio is 40 percent, interest is 9 percent. Calculate Buddys EPS and ROE for each capital structure. Which capital structure is better? Why? – Please show how the work is done.

ANSWER

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