You work for the CEO of a new company that plans to manufacture and sell a new t

Question

You work for the CEO of a new company that plans to manufacture and sell a new type of laptop computer. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $600,000. Other data for the firm 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 Oper. income (EBIT) $600,000 $600,000 Required investment $2,500,000 $2,500,000 % Debt 0.0% 60.0% $ of Debt $0.00 $1,500,000 $ of Common equity $2,500,000 $1,000,000 Shares issued, $10/share 250,000 100,000 Interest rate NA 10.00% Tax rate 35% 35%. Show work.

Explanation / Answer

1.56

Lower

2.925

Lower

0% Debt 60% Debt Debt Amount $ 0 1500000 Interest on Debt @ 10% ($) 0 150000 Expected Operating income $ 600000 600000 - Interest on Debt 0 150000 Income before tax 600000 450000 - Tax 210000 157500 Income after tax (A) 390000 292500 No. of shares (B) 250000 100000 Earning per share

1.56

Lower

2.925

Lower

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