GTB, Inc., has a 20 percent tax rate and has $53.13 million in assets, currently
ID: 2745423 • Letter: G
Question
GTB, Inc., has a 20 percent tax rate and has $53.13 million in assets, currently financed entirely with equity. Equity is worth $5 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 20-percent-debt capital structure, and has determined that it would have to pay a 12 percent yield on perpetual debt in either event. What will be the level of expected EPS if GTB switches to the proposed capital structure?
State Pessimistic Optimistic Probability of state 0.45 0.55 Expected EBIT in state $ 3,506,250 $ 14,981,250Explanation / Answer
EPS = Net Income available to equity shareholders / No of shares outstanding
No of shares out standing =[ (1-0.2)*$53130000]/$5 =10626000 shares
Total Interest = 0.12*0.2*53130000=$1275120
EPS in Pessimistic:
Net income = EBIT - Interest -Tax@20% on EBT =$3506250-1275120 - (3506250-1275120)*0.20
=2231130-446226=$1784904
EPS = $1784904/10626000=$0.17
EPS in Optimistic:
Net income = EBIT - Interest -Tax@20% on EBT =$14981250-1275120-(14981250-1275120)*0.2
=13706130-2741226=$10964904
EPS = $10964904 /10626000=$1.032
Expected EPS = (0.45*0.17)+(0.55*1.032)=0.0765+0.568=$0.6445
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