Aspeon Sparkling Water

Aspeon Sparkling Water, Inc.

Capital Structure

Comm420 

Dr. Raymond Cox

Gengsi Ma

Hairun Wang

Ming Zhao

Yukun Zhao

Q1.

a. A business risk is a circumstance or factor that may have a negative impact on the operation or profitability of a given company. Sometimes referred to as company risk. Financial risk is the extra risk added by stockholders as a result of the use of financing the debt.

b. In the total risk sense, one common measure of business and financial risk is the variability of Return On Equity, also known as the standard deviation. The difference is a measure of financial risk:

Total risk = Return On Equity.

Business risk = Return On Equity (Unlevered)

Financial risk = ROE — ROE(Unlevered)

c. An unlevered firm's beta depends solely on the firm's business risk, but the use of financial leverage causes the firm's beta to increase. Thus, within a market risk framework:

Total market risk = bL

Business market risk = bU

Financial market risk = bL — bU

d. Business risk is the single most important determinant of a firm's capital structure. The greater the risk inherent in a firm's assets, then, at any debt level, the greater the probability of financial distress for the firm. Also, the greater the business risk, the greater kd and ks would be for the firm as the firm's debt ratio increases.

Q2.

| | All Equity | | | 50% Debt | |

Probability | 0.25 | 0.50 | 0.25 | 0.25 | 0.50 | 0.25 |

EBIT | $10,000,000 | $32,000,000 | $54,000,000 | $10,000,000 | $32,000,000 | $54,000,000 |

Interest | 0 | 0 | 0 | 7,800,000 | 7,800,000 | 7,800,000 |

EBT | $10,000,000 | $32,000,000 | $54,000,000 | $2,200,000 | $24,200,000 | $46,200,000 |

Taxes | 4,000,000 | 12,800,000 | 21,600,000 | 880,000 | 9,680,000 | 18,480,000 |

Net Income | $6,000,000 | $19,200,000 | $32,400,000 | $1,320,000 | $14,520,000 | $27,720,000 |

ROE | 5.0% | 16.0% | 27.0% | 2.2% | 24.2% | 46.2% |

TIE | n.a. | n.a. | n.a. | 1.28 | 4.10 | 6.92 |...