HiLo, Inc., doesn’t face any taxes and has $67.92 million in assets, currently f

Question

HiLo, Inc., doesn’t face any taxes and has $67.92 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 below:

The firm is considering switching to a 25-percent-debt capital structure, and has determined that it would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if the firm switches to the proposed capital structure? (Do not round intermediate calculations and round your final answer to 2 decimal places.)

HiLo, Inc., doesn’t face any taxes and has $67.92 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 below:

Explanation / Answer

EPS calculation:

Pessimistic Optimistic EBIT 2,037,600 14,857,500 Interest: Total assets 67,920,000 Debt(25%) 16,980,000 Interest @9% 1,528,200 -1,528,200 -1,528,200 EBT 509,400 13,329,300 Less: Taxes 0 0 A PAT 509,400 13,329,300 Number of equity shares: Total assets 67,920,000 Equity(75%) 50940000 Value per share 6 B Number of equity shares 8490000 8490000 8490000 A/B EPS 0.06 1.57

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