Your company doesn\'t face any taxes and has $268 million in assets, currently f

ID: 2821865 • Letter: Y

Question

Your company doesn't face any taxes and has $268 million in assets, currently financed entirely with equity. Equity is worth $9.8 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 25-percent debt capital structure, and has determined that they would have to pay a 11 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? (Round your intermediate calculations and final answer to 2 decimal places except calculation of number of shares which should be rounded to nearest whole number.)

$3.97

$1.99

$2.38

$2.96

State Pessimistic Optimistic Probability of State .30 .70 Expect EBIT in State $28 million $68 million

Explanation / Answer

EBIT

(.3*28)+(.7*68)

56.00

less Interest =(268*25%*11%)

7.37

EBT

48.63

no of shares after recapitalization = before capitalization value of assets*(1-debt rate)

6.836735

EPS = EBT/no of shares

48.63/20.51

2.37

or equal to 2.38

no of shares after recapitalization = before capitalization value of assets*(1-debt rate) / EPS

(268*75%)/9.8