Consider a firm with an EBIT of $558,000. The firm finances its assets with $1,0
ID: 2779804 • Letter: C
Question
Consider a firm with an EBIT of $558,000. The firm finances its assets with $1,080,000 debt (costing 6.3 percent) and 208,000 shares of stock selling at $12.00 per share. The firm is considering increasing its debt by $900,000, using the proceeds to buy back 83,000 shares of stock. The firm is in the 30 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $558,000. Calculate the change in the firm’s EPS from this change in capital structure. (Round your answers to 2 decimal places.)
Explanation / Answer
Current EPS
EBIT = $558,000
Profit before tax = $558,000 - ($1,080,000 × 6.30%)
= $558,000 - $68,040
= $489,960.
Net Income = $489,960 × (1 - 30%)
= $342,972.
Current EPS = $342,972 / 208,000
= $1.65
Current EPS of company is $1.65.
New Capital structure
Value of debt issue = $900,000
Total Value of debt after issue = $1,080,000 + $900,000
= $1,980,000
Number of share remains after repurchase = 208,000 - 83,000
= 125,000.
Profit before tax = $558,000 - ($1,980,000 × 6.30%)
= $558,000 - $124,740
= $433,260
Net Income = $433,260 × (1 - 30%)
= $303,282
New EPS = $303,282 / 125,000
= $2.43
New EPS of company is $2.43
change in EPS = $2.43 - $1.65
= $0.78
Dollar Change in EPS is $.78.
Percentage change in EPS = $0.78 / $1.65
= 47.14%
Percentage change in EPS is 47.14%.
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