GTB, Inc., has a 20 percent tax rate and has $68.56 million in assets, currently

Question

GTB, Inc., has a 20 percent tax rate and has $68.56 million in assets, currently financed entirely with equity. Equity is worth $6 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: State Pessimistic Optimistic Probability of state 0.40 0.60 Expected EBIT in state $ 3,213,750 $ 14,783,250 The firm is considering switching to a 25-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? (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Explanation / Answer

Share price Before Debt issue 6 Total Value of equity (assets finance) 68560000 No. of shares 11426667 D;E 25% Value of proposed equity (68.56 x 75%) 51420000 No. of shares 51420000/6 8570000 Value of proposed debt (68.56 x 25%) 17140000 Interest on debt 17.14 8 10%) 1714000 Tax rate 20% Optimistic Pessimistic Probability 0.6 0.4 EBIT 14783250 3213750 Less: Interest 1714000 1714000 EBT 13069250 1499750 Tax @ 20% 2613850 299950 PAT (Total Earnings) 10455400 1199800 No of shares 8570000 8570000 EPS 1.22 0.14 Probability X EPS 0.732 0.056 Expected EPS (.732+.056) 0.788 Please provide feedback…. Thanks in advance…. :-)

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