GTB, Inc., has a 25 percent tax rate and has $57.40 million in assets, currently

Question

GTB, Inc., has a 25 percent tax rate and has $57.40 million in assets, currently financed entirely with equity. Equity is worth $5 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:

State Pessimistic Optimistic

Probability of state 0.45 0.55

Expected EBIT in state $1,980,300 $14,378,700

The firm is considering switching to a 25-percent-debt capital structure, and has determined that it would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if GTB switches to the proposed capital structure?

Expected EPS $ _______

Explanation / Answer

5,630,940

2)

probability EBIT Expected EBIT pessimistic .45 1,980,300 891,135 optimistic .55 14,378,700 7,908,285 Expected EBIT 8,799,420 less : Interest    [14,350,000 .09] (1,291,500) EBT 7,507,920 Less Tax     [EBT*.25 ] ( 1,876,980) Earning after tax (EAT)

5,630,940

Number of shares 8,610,000 EPS [EAT /Number of shares] $ .654 per share

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