Your company doesn\'t face any taxes and has $511 million in assets, currently f
ID: 2619971 • Letter: Y
Question
Your company doesn't face any taxes and has $511 million in assets, currently financed entirely with equity. Equity is worth $41.10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below:
The firm is considering switching to a 25-percent debt capital structure, and has determined that they would have to pay a 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? (Round your intermediate calculations and final answer to 2 decimal places except calculation of number of shares which should be rounded to nearest whole number.)
Explanation / Answer
Solution: Expected EPS =$11.35 Working Notes: Interest cost in all cases = Interest rate x 25% x total assets =8% x (25% X $511,000,000) = $10,220,000 No. of shares outstanding = 75% X Total assets / Market price per share =75% x $511,000,000/$41.10 = 9,324,817.51824 =9,324,818 Shares EPS when in capital structure 25% is debt in each situation of economy State Recession Average Boom EBIT 61,000,000 111,000,000 181,000,000 Less: Interest 10,220,000 10,220,000 10,220,000 EBT 50,780,000 100,780,000 170,780,000 Less: Taxes @ 0% 0 0 0 Net Income (EAT) (a) 50,780,000 100,780,000 170,780,000 ÷ No. of shares (b) 9,324,818 9,324,818 9,324,818 EPS (a/b) 5.45 10.81 18.31 Probability 0.25 0.50 0.25 Expected EPS = Sum of (EPS x Prob.) =5.45 x 0.25 + 10.81 x 0.50 + 18.31 x 0.25 =11.345 =$11.35 Please feel free to ask if anything about above solution in comment section of the question.
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