HiLo, Inc., doesn’t face any taxes and has $256 million in assets, currently fin

Question

HiLo, Inc., doesn’t face any taxes and has $256 million in assets, currently financed entirely with equity. Equity is worth $15 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                  0.40               0.60

Expected EBIT in state $ 3,584,000          $ 18,816,000

The firm is considering switching to a 25-percent-debt capital structure, and has determined that it would have to pay a 12 percent yield on perpetual debt in either event. What will be the level of expected EPS if the firm switches to the proposed capital structure? (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Explanation / Answer

Total Assets 256000000 Equity portion @ 75% 192000000 Debt portion @ 25% 64000000 Interest on Debt @ 12% 7680000 Number of Shares = total Equity after Debt/Value per shares 21333333.3 State       Pessimistic Optimistic Total Probability of state 0.4 0.6 1 Expected EBIT in state 3584000 $18,816,000 $18,816,000 EBIT Total 1433600 11289600 18816000 Eps calculation based on state Pessimistic Optimistic Particulars EBIT 1433600 11289600 Interest 7680000 7680000 EBT or EAT(Tax free) -6246400 3609600 EPS = EAT or earnings available to shareholders/Number of equity shares -0.29 0.17

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