4) Fli-Bi-Nite Radiology, a company offering radiology services, is considering

Question

4) Fli-Bi-Nite Radiology, a company offering radiology services, is considering buying a $6M radiology suite. Depending on the volume of business, the suite is estimated to generate an annual EBIT of between $2, $3, or $4 million. The probabilities of these revenue streams are: 30%, 60% and 10%. Two financing plans are to be considered. 100% stock, or 55% stock and 45% debt. Assuming the new stock could be sold for $20 per share, that debt has a 10% interest rate, and the tax rate is 40%; calculate the expected EPS for each scenario. If the P/E ratio is 15, what is the expected price of the stock? Which scenario would you recommend and why?

Explanation / Answer

4) Expected EBIT would be = Probability of first scenario* Annual EBIT + Probability of second scenario* Annual EBIT + Probability of third scenario* Annual EBIT

Or, Expected EBIT = $2*30% + $3*60% + $4*10% = $2.8million

Now, for the first option (where 100% equity is expected);

Cost of the radiology suite is $6million

Now if the Price assumed to be $20

Then Market Capitalization=> Price per share * No. of shares issued

Or, No. of shares issued = $6/20= $0.3million

EBIT =                                                        $2.8 million

Less; Interest                                                 0

EBT (earnings before tax)                      $2.8 million

Less Taxes @40%                                     $1.12 million

EAT (earnings after tax)                          $1.68 million

Again EPS = EAT/ no. of outstanding shares

Again EPS = $1.68/0.3 = 5.6

If P/E ratio is 15, then MPS/ EPS = 15

Or, Price (expected) = $5.6*15 = $84 per share

Now for the Second Option is (55% Equity and 45% stock);

Since the buying of the radiology suite would cost $6million so;

Equity will be = $6*0.55 = $3.3million

Debt will be = $6*0.45= $2.7 million

Market Capitalization=> Price per share * No. of shares issued

Or, No. of shares issued = $3.3/20= $0.165million

EBIT =                                                        $2.8 million

Less; Interest ($2.7*10%)                      $0.27

EBT (earnings before tax)                      $2.53million

Less Taxes @40%                                     $1.01 million

EAT (earnings after tax)                          $1.518 million

Again EPS = EAT/ no. of outstanding shares

Again EPS = $1.518/0.165 = 9.2

If P/E ratio is 15, then MPS/ EPS = 15

Or, Price (expected) = $9.2*15 = $138 per share

Option I (100% Equity)

Option II (55% Equity & 45% Debt)

Expected Market Price Per Share

$84

$138

So it’s better to go for Option II since price Maximization is found there as $138> $84. Hence option II is recommended.

Option I (100% Equity)

Option II (55% Equity & 45% Debt)

Expected Market Price Per Share

$84

$138

Related Questions

Navigate

• Browse (All)
• Browse 4
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.