Buchanan Brothers anticipates that its net income at the end of the year will be

Question

Buchanan Brothers anticipates that its net income at the end of the year will be $3.6 million (before any recapitalization). The company currently has 900,000 shares of common stock outstanding and has no debt. The company’s stock trades at $40 a share. The company is considering a recapitalization, where it will issue $10 million worth of debt at a yield to maturity of 10 percent and use the proceeds to repurchase common stock. Assume the stock price remains unchanged by the transaction, and the company’s tax rate is 34 percent. What will be the company’s earnings per share, if it proceeds with the recapitalization?

Can someone help me how to solve this problem? I know that the answer suppose to be 2.23

Explanation / Answer

EBIT $       6,000,000 3600000/(1-40%) Less: Interest $       1,000,000 10000000*10% Profit before tax $       5,000,000 Tax @ 34% $       1,700,000 Net income $       3,300,000 Less: Preference dividends $                      -   Net income available to common stockholders $       3,300,000 ÷Number of shares               650,000 900000-10000000/40 EPS $                  5.08

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