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Financial Ratios and Risk Analysis

Blemker Corporation has $500 million of total assets, its basic earning power is 15%, and it currently has no debt in its capital structure. The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged. Which of the following is most likely to occur as a result of the recapitalization?

a. The ROA would increase.
b. The ROA would remain unchanged.
c. The basic earning power ratio would decline.
d. The basic earning power ratio would increase.
e. The ROE would increase.

Which of the following statements would be true?

a. A firm's business risk is determined solely by the financial characteristics of its industry.
b. The factors that affect a firm's business risk are affected by industry characteristics and economic conditions. Unfortunately, these factors are generally beyond the control of the firm's management.
c. One of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy.
d. A firm's financial risk can be minimized by diversification.
e. The amount of debt in its capital structure can under no circumstances affect a company's business risk.

Solution Preview

Blemker Corporation has $500 million of total assets, its basic earning power is 15%, and it currently has no debt in its capital structure. The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value. If the company proceeds with the recapitalization, its operating income, total assets, and tax ...

Solution Summary

This solution provides the correct answers with explanations to the financial and risk analysis questions listed.

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