Capital Structure Analysis

The Rivoli Company has no debt outstanding, and its financialposition is given by the following data:

Assets (Market value = book value)	$3,000,000
EBIT	$500,000
Cost of equity, rs	10%
Stock price, Po	$15
Shares outstanding, no	200,000
Tax rate, T (federal-plus-state)	40%

The firm is considering selling bonds and simultaneouslyrepurchasing some of its stock. If it moves to a capital structurewith 30% debt based on market values, its cost of equity,r_s, will increase to 11% to reflect the increased risk.Bonds can be sold at a cost, r_d, of 7%. Rivoli is ano-growth firm. Hence, all its earnings are paid out as dividends.Earnings are expected to be constant over time.

1. What effect would this use of leverage have on the value of thefirm?
   I. Increasing the financial leverage by addingdebt results in an increase in the firm's value.
   II. Increasing the financial leverage by addingdebt results in a decrease in the firm's value.
   III. Increasing the financial leverage by addingdebt has no effect on the firm's value.
   -Select-IIIIIIItem 1
   
2. What would be the price of Rivoli's stock? Do not roundintermediate calculations. Round your answer to the nearestcent.
   $   per share
   
3. What happens to the firm's earnings per share after therecapitalization? Do not round intermediate calculations. Roundyour answer to the nearest cent.
   The firm -Select-increaseddecreasedItem 3 its EPS by$   .
   
4. The $500,000 EBIT given previously is actually the expectedvalue from the following probability distribution:

   Probability	EBIT
   0.10	($ 110,000)
   0.20	250,000
   0.40	450,000
   0.20	850,000
   0.10	1,110,000

   
   Determine the times-interest-earned ratio for each probability. Usea minus sign to enter negative values, if any. Do not roundintermediate calculations. Round your answers to two decimalplaces.

   Probability	TIE
   0.10
   0.20
   0.40
   0.20
   0.10

   
   What is the probability of not covering the interest payment at the30% debt level? Do not round intermediate calculations. Round youranswer to two decimal places.
   
     %