Garson Corp. is looking at two possible capital structures. Currently, the firm
ID: 2702689 • Letter: G
Question
Garson Corp. is looking at two possible capital structures. Currently, the firm is an all-equity firm with $1.2 million dollars in assets and 200,000 shares outstanding. The market value of each share of stock is $6.00. The CEO of Garson is thinking of leveraging the firm by selling $600,000 of debt financing and retiring 100,000 shares, leaving 100,000 outstanding. The cost of debt is 10% annually, and the current corporate tax rate for Garson is 30%. If the CEO believes that Garson will earn $100,000 per year before interest and taxes, should she leverage the firm? Explain.
Answer Hint: Find the EPS under the two financing structures with an EBIT of $100,000:
Explanation / Answer
With All-Equity EPS = $100,000*(1-0.3) / 200,000 = $0.35
Annual Interest Payment for Debt = $600,000
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