Fresh out of Harvard Business School, Joe Walker, the new CFO of Joe\'s Southern

Question

Fresh out of Harvard Business School, Joe Walker, the new CFO of Joe's Southern Cornbread Company, wants to shake things up at the sleepy little food company headquartered in Birmingham, Alabama. The firm is currently an all-equity firm because "that's the way we've always done it." Under pressure from a new group of major stockholders, however, Walker is considering acquiring some debt (leverage) in an effort to boost earnings per share. The company currently has 600 shares, but he is thinking about borrowing $6,000 at 10% per year and buying back 200 of those shares. Refer to the scenario above. If Southern Cornbread's EBIT is $1,800, compare EPS before and after the new debt

Explanation / Answer

Before =>

EPS = total earning/ no. of shares

= 1800 / 600

=$3

After = >

Eps = 7800/ (600 - 200)

= $ 19.50

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