Your girlfriend plans to start a new company to make a new type of cat litter. H

Question

Your girlfriend plans to start a new company to make a new type of cat litter. Her father will finance the operation, but she will have to pay him back. You are helping her, and the issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per unit will be $10.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other information, are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL - EPSU?

0% Debt, U 60% Debt, L Expected unit sales 225,000 225,000 Price per unit $10.00 $10.00 Fixed costs $1,000,000 $1,000,000 Variable cost/unit $3.50 $3.50 Required investment $2,500,000 $2,500,000 Shares issued at $10/share 250,000 100,000 % Debt 0.00% 60.00% Debt, $ $0 $1,500,000 Equity, $ $2,500,000 $1,000,000 Interest rate NA 10.00% Tax rate 35.00% 35.00%

Explanation / Answer

c. $0.60

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