Watson Waterbed Works Inc. has an EBIT of $2.75 million, can borrow at 15% interest, and pays

| June 9, 2016

Question
Watson Waterbed Works Inc. has an EBIT of $2.75 million, can borrow at 15% interest, and pays

Practical Financial Management By William Lasher 5th Edition

4. Watson Waterbed Works Inc. has an EBIT of $2.75 million, can borrow at 15% interest, and pays combined state and federal income taxes of 40%. It currently has no debt and is capitalized by equity of $12 million. The firm has 1.5 million shares of common stock outstanding that trade at book value.

a. Calculate Watson’s EAT, ROE, and EPS currently and at capital structures that have 20%, 40%, 60%, and 80% debt.

b. Compare the EPS at the different leverage levels, and the amount of change between levels as leverage increases. What happens to the effect of more debt as leverage increases from a little to a lot?

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