High Sky, Inc., a hot-air balloon manufacturing firm, currently has the followin
ID: 2626505 • Letter: H
Question
High Sky, Inc., a hot-air balloon manufacturing firm, currently has the following simplified balance sheet:
Assets
Liabilities and Capital
Total Assets
$ 1,100,000
Bonds (10% interest)
$ 600,000
Common Stock at par ($3), 100,000
shares outstanding
$ 300,000
Contributed capital in excess of par
$ 100,000
Retained earnings
$ 100,000
Total libalities and capital
$ 1,100,000
The company is planning an expansion that is expected to cost $600,000. The expansion can be financed with new equity (sold to net the company $4 per share) or with the sale of new bonds at an interest rate of 11 percent. (The firm
Assets
Liabilities and Capital
Total Assets
$ 1,100,000
Bonds (10% interest)
$ 600,000
Common Stock at par ($3), 100,000
shares outstanding
$ 300,000
Contributed capital in excess of par
$ 100,000
Retained earnings
$ 100,000
Total libalities and capital
$ 1,100,000
Explanation / Answer
While deciding on the appropriate capital structure for an organisation, the first thing is to understand the affect on Earning Per Share (EPS) due to the changes in Earning Before Interest and Taxes (EBIT) under different financing alternatives.
The relationship between EBIT and EPS is as follows:
(EBIT
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