Your company doesn\'t face any taxes and has $518 million in assets, currently f

Question

Your company doesn't face any taxes and has $518 million in assets, currently financed entirely with equity. Equity is worth $41.80 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 Recession Average Boom

Probability of State .25 .55 .20

Expect EBIT in State $68 million $118 million $188 million

The firm is considering switching to a 15-percent debt capital structure, and has determined that they would have to pay a 11 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.)

$11.02

$10.53

$33.07

$17.04

Explanation / Answer

Interest in all states will be equal to 0.11*(0.15*518,000,000) =$8,547,000 and number of shares outstanding will be equal to (0.85*518,000,000)/41.80 =$10,533,493

the EPS in each state of nature will be as shown:

EPS with 15% Debt

the expected EPS will be equal to (0.25*0.56)+(0.55*10.39)+(0.20*17.04) = $9.26

State Recession Average Boom EBIt 68,000,000 118,000,000 188,000,000 -Interest 8,547,000 8,547,000 8,547,000 EBt 59,453,000 109,453,000 179,453,000 - taxes@0% 0 0 0 Net income 59,453,000 109,453,000 179,453,000 EPS 0.56 10.39 17.04

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