Barette Consulting currently has no debt in its capital structure, has $500 million of total assets, and its return on invested operating capital (ROIC) is 14.5%.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 remain unchanged.
B) The ROIC would decline.
C) The ROIC would increase.
D) The ROE would increase.
E) The ROA would increase.

Question

Quizplus · Accepted Answer

The recapitalization involves issuing debt to repurchase equity. This leverages the company's capital structure, increasing the return on equity (ROE) because it reduces the equity base while maintaining or potentially increasing earnings (due to interest tax shields), assuming operating income remains constant.

Barette Consulting Currently Has No Debt in Its Capital Structure