Your company doesn\'t face any taxes and has $253 million in assets, currently f

Question

Your company doesn't face any taxes and has $253 million in assets, currently financed entirely with equity. Equity is worth $8.3 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:

  Expect EBIT in State

The firm is considering switching to a 30 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.)

$53 million

State Pessimistic Optimistic   Probability of State .35 .65

  Expect EBIT in State

The firm is considering switching to a 30 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.)

$13 million

$53 million

Explanation / Answer

* $ 253,000,000 / $ 8.3 x 70% = 21,337,350 shares

Pessimistic Optimistic EBIT $ 13,000,000 $ 53,000,000 Less Interest 6,072,000 6,072,000 Net income 6,928,000 46,928,000 Number of common shares 21,337,350* 21,337,350 EPS $ 0.32 $ 2.20

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