GTB has a 25% tax rate and has $85.80 million in assets, currently financed enti
ID: 2752343 • Letter: G
Question
GTB has a 25% tax rate and has $85.80 million in assets, currently financed entirely with equity. Equity is worth $6 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: Probability of state 0.40 (pessimistic) 0.60 (optimistic) Expected EBIT in state $3,432,000 (pessimistic) $15,672,800 (optimistic). The firm is considering switching to a 40% debt capital structure, and has determined that it would have to pay a 9% yield on perpetual debt in either event. What will be the level of the expected EPS if GTB switches to the proposed capital structure? Please show work.
Explanation / Answer
The expected EPS if GTB switches to the proposed capital structure is = $ 0.67
The calculations are given below:
Expected State of the Economy Probability EBIT Value Pessimistic 0.4 3,432,000 1372800 Optimistic 0.6 15,672,800 9403680 10776480 Expected value of EBIT 10,776,480 Interest on perpetual debt 3,088,800 (85,800,000 * 0.4 * 0.09) EBT 7,687,680 Tax @ 25% 1,921,920 1921920 EAT 5,765,760 Number of shares if 40% debt structure is adopted 8,580,000 (85800000*.6)/6 Expected EPS 0.672 say 0.67Related Questions
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