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Your company doesn\'t face any taxes and has $263 million in assets, currently f

ID: 2745370 • Letter: Y

Question

Your company doesn't face any taxes and has $263 million in assets, currently financed entirely with equity. Equity is worth $9.3 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below:


The firm is considering switching to a 15-percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? (Round your intermediate calculations and final answer to 2 decimal places except calculation of number of shares which should be rounded to nearest whole number.)

O $3.25

O $2.46

O $1.63

O $2.13

State Pessimistic Optimistic   Probability of State .20 .80   Expect EBIT in State $23 million $63 million

Explanation / Answer

1) Answer (D) $2.13

Calculation :

Expected EBIT = $55,000,000 **(23000000*0.20+63000000*80)

Number of shares = 263,000,000 / 9.3

= 28279570 shares

EPS = 55000000 / 28279570

= $1.944

With New Debt Structure :

Debt value = 263,000,000 * 15/100

= $39,450,000

Equity value = $223,550,000

New no.of equity shares = 223550000 / 9.3

= 24037634

Interest on Debt = $3,945,000

Earnings available to equity shareholders = 55,000,000 - 3,945,000

= 51,055,000

  New EPS = 51,055,000 / 24037634

   = $2.13 (Approx)

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