Your company doesn\'t face any taxes and has $510 million in assets, currently f
ID: 2811051 • Letter: Y
Question
Your company doesn't face any taxes and has $510 million in assets, currently financed entirely with equity. Equity is worth $41.00 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 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.)
$9.75
$10.24
$16.23
$30.72
State Recession Average Boom Probability of State .25 .55 .20 Expect EBIT in State $60 million $110 million $180 millionExplanation / Answer
Hence, expected EBIT is $111.5 million
Current investment in assets = $510 million
Proposed debt financing = 15%
=510 x 15%
= $76.5 million
Interest on debt = 11%
= 76.5 x 11%
= $8.415 million
Hence, equity financing = 510 - 76.5
= $433.5 million
Book value of 1 share = $41
Hence, number of outstanding shares = 433.5 x 1,000,000/41
= 10,573,171
Earnings after interest = EBIT - Interest
= 111.5 - 8.415
= $103.085 million
EPS = Earnings after interest/Number of outstanding shares
= 103.085 x 1,000,000/10,573,171
= $9.75
Hence, correct option is (a)
Kindly give a positive rating if you are satisfied with the answer. Feel free to ask if you have any doubts. Thanks.
State Probability (i) Expected EBIT (ii) Product (i) x (ii) Recession 0.25 $60 million $15 million Average 0.55 $110 million $60.5 million Boom 0.20 $180 million $36 million total $111.5 millionRelated Questions
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