GTB, Inc., has a 20 percent tax rate and has $53.00 million in assets, currently
ID: 2754068 • Letter: G
Question
GTB, Inc., has a 20 percent tax rate and has $53.00 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 10 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 $ 3,498,000 $ 14,946,000Explanation / Answer
In the Current Scenario Equity Base - $ 53 million Face Value per share - $ 5 In the revised scenarios (both states) (Values in $) Pessimistic Optimistic Probability of State 0.45 0.55 EBIT 3498000 14946000 Adjusted EBIT based on Probability 1574100 8220300 Interest @ 10% on Debt 1060000 1060000 (Debt is 20% of $ 53 million = $ 10.6 million) EBT 514100 7160300 Equity Base Value is 80% of $ 53 million = $ 41.4 million Face Value per share = $ 5 No. of Equity Shares 8280000 8280000 EPS in $ 0.062089 0.864770531 (EBT/No. of shares)
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