Giant corp is a small looking looking at two possibe captial structures. Current

ID: 2702666 • Letter: G

Question

Giant corp is a small looking looking at two possibe captial structures. Currently the firm is an all

equity firm with 900,000 in assets and 100,00 shares outstanding. The market value of each share

is $9. the CEO of Giant is thinking of leveraging the firm by selling $270,000 of the debt financing and

retiring 30,000 shares , leaving 70,000 shares outstanding. The cost of the debt is 6% annually and

the current corporate tax rate for Donat is 30%. The CEO believes that Donat will earn $100,000 per year

before interest and taxes. Which of the statement below is true?

A. 50/50 debt to equity EPS is $0.838

B. All equity EPS is $.70

C. Shareholder will be better off by almost $.14 per share under a firm with $270,000 in debt financing

versus a firm that is all equity

D. Statments A through C are all true

EPS if it is a all equity firm

EPS= 100000x.7/100000= .7

EPS if using debt plus equity

EPS= [(100000-6%x270000)x.7]/70000= .838 or .84

Shareholder will be better off by almost (.84-.7) $.14 per share under a firm with $270,000 in debt financing

versus a firm that is all equity

Therefore (c) is the correct answer.

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