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ABOUT 25 YEARS AGO, WHEN JAPANESE COMPANIES WERE "EATING

ABOUT 25 YEARS AGO, WHEN JAPANESE COMPANIES WERE "EATING

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Author: Joyce Buda
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http://theperfecthomework.com/about-25-years-ago-when-japanese-companies-were-eating-our-lunch-many-analysts-noted-that-those-companies-had-highly-leveraged-capital-structures-lots-of-debt-and-little-equity/


1. About 25 years ago, when Japanese companies were "eating our lunch", many analysts noted that those companies had highly leveraged capital structures -- lot's of debt and little equity. Looking at the WACC formula suggests that more debt relative to equity might lower WACC. Is leverage "always" good or "always" bad? If it depends on the industry, please suggest which ones would be expected to have greatest and least leverage.
2. Imagine two independently owned gas stations standing next to each other and selling gas (and other goods) at about the same price, so they have the same revenues, cost structure and effective tax rate of 35%. Assume that every year they have average EBIT of $ 500,000 (I know, it's quite optimistic) without any anticipated growth. One owner finances all operations out of own pocket, while another borrows $ 500,000 for five years and refinances this debt every five years without repaying principal.
Discuss the difference in value (if any) of these two stations.


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