Daddi Mac, Inc., doesn’t face any taxes and has $313.00 million in assets, curre
ID: 2788007 • Letter: D
Question
Daddi Mac, Inc., doesn’t face any taxes and has $313.00 million in assets, currently financed entirely with equity. Equity is worth $40 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 an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if the firm switches to the proposed capital structure? (Do not round intermediate calculations and round your final answer to 2 decimal places.)
State Recession Average Boom Probability of state 0.25 0.55 0.20 Expected EBIT in state $ 6,134,800 $ 11,080,200 $ 18,091,400Explanation / Answer
1) Firstly we determine the expected EBIT...........For this just multiply the EBIT values with their probabilities and total the results. i.e 6,134,800 * 0.25 + 11,080,200 * 0.55 + 18,091,400 * 0.20 = 11,246,090.
2) Number of shares ( common stock) ........313,000,000 / 40 = 7,825,000
After buy back of 20% the revised number of shares = 7,825,000 * 0.80 = 6260000
3) Debt = 313,000,000 * 0.20 = 62,600,000
I = Interest = 62600000 * 0.08 = 5,008,000
EPS = ( EBIT - I ) (1 - Tax rate) / No of shares
= (11,246,090.- 5,008,000 ) * ( 1 - 0.00) / 6260000 = 0.9965.. or 1.00 ......final answer
Note : The question is silent about tax rate. If there is a tax rate = 40% is assumed then
EPS = (11,246,090.- 5,008,000 ) * ( 1 - 0.40) / 6260000 = 0.5979 .... or .... 0.60........final answer
Kindly check for tax information and select the correct answer. If you want further help ....plz comment
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