Sinclair, Inc. is a levered firm with a leverage factor of 2. Sinclair’s assets
ID: 2769678 • Letter: S
Question
Sinclair, Inc. is a levered firm with a leverage factor of 2. Sinclair’s assets are valued at $5,000 and they pay a 10% coupon rate on their debt. Sinclair pays tax at the rate of 34%. The firm faces EBIT scenarios of recession and boom. {Note: EBIT = earnings before interest and tax, $ Interest = dollar amount of interest owed on the debt, NIBT = net income before tax, NI = net income, EPS = earnings per share}. Assume that firms with negative NIBT pay zero tax.
BOOM (EBIT= $900) (EPS= $0.78)
RECESSION (EBIT= $200) (NIBT= -$50)
13. What amount comes closest to the amount of interest that Sinclair must pay in the BOOM scenario?
A. $250
B. $300
C. $350
D. $400
E. $450
14. What amount comes closest to Sinclair’s NI in the BOOM scenario?
A. $850
B. $529
C. $429
D. $150
E. -$150
Explanation / Answer
Question 13:
Leverage factor = total assets / total debt
2 =5000 / total debt
Total debt = 2500
Interest = total debt x coupon rate
= 2500 x 10%
= 250
Question 14:
Net Income = ( EBIT – interest) x (1-t)
= (900 -250) x (1-0.34)
= 650 x 0.66
= 429