Capital Structure Decisions
Consider the following scenario:
You are the Comptroller for a healthcare organization and you are tasked with analyzing potential scenarios regarding their funding.
Problem #1: Changing Debt & Interest Rates
- They have an operating income of 1,500,000 SAR
- They have assets of 7,500,000 SAR
- The Tax rate is 22.5%
- They currently do not have any debt but are considering the following scenarios:
Scenario A
No debt
Scenario B
Interest rate 9.5%
B1 increase debt to 2,500,000 SAR
B2 increase debt to 5,000,000 SAR
Scenario C
Interest rate 12.5%
B1 increase debt to 2,500,000 SAR
B2 increase debt to 5,000,000 SAR
Based on the above information, address the following questions:
Compare Scenario A (no debt) to Scenario B (increasing debt 9.5% interest rate)
a. What impact does increasing the debt have on the taxable income?
- What impact does increasing the debt have on the net income?
- What impact does increasing the debt have on the dollar return to investors?
Compare Scenario B (increasing debt 9.5% interest rate) to Scenario C (increasing debt 12.5% interest rate)
a. What impact does the higher interest rate have on the taxable income?
- What impact does the higher interest rate have on the net income?
- What impact does the higher interest rate have on the dollar return to investors?
Key points
a. How does debt financing influence ROE?
- Increasing debt can have what impact on the amount of tax paid?
- A higher interest rate can have what effect on the level of taxes paid?
- A higher interest rate can have what effect on the dollar return to investors?
- How does a higher interest rate affect ROE?
Problem #2: Uncertainty
Scenario D
Zero Debt
Calculate:
a. The expected net income for each probability
- The expected dollar return to investors for each probability
- The expected ROE for each probability
- What the company can expect its net income to be given these probabilities
- What the company can expect dollar return to investors to be given these probabilities
- What the company can expect its ROE to be given these probabilities
Scenario E
However, assume the company now has 5,000,000 SAR Debt
Calculate:
a. The expected net income for each probability
- The expected dollar return to investors for each probability
- The expected ROE for each probability
- What the company can expect its net income to be given these probabilities
- What the company can expect dollar return to investors to be given these probabilities
- What the company can expect its ROE to be given these probabilities
Based upon those calculations answer the following questions:
a. Does the increased leverage offer the potential of an increased ROE?
- What impact does the increased leverage have on the risk to stock holders?
- Is it always a good idea to use debt financing?
Make recommendations to the organization as to the course of action that they should follow considering all risk factors. Please make certain that you show your calculations. Submit your findings in a proposal to the hospital.
Your paper should meet the following structural requirements:
- five pages in length, not including the cover sheet and reference page.
- You must show all your calculations for credit. Your calculations for this assignment must be submitted as an Excel file, identified as Appendix A, and included as part of the Word document submission.
- Formatted according to APA 7th edition and Saudi Electronic University writing standards
- Provide support for your statements with in-text citations from a minimum of six scholarly articles.
