Question

Consider a firm with an EBIT of $866,000. The firm finances its assets with $2,660,000 debt (costing 8 percent and is all tax deductible) and 560,000 shares of stock selling at $5.00 per share. To reduce the firm’s risk associated with this financial leverage, the firm is considering reducing its debt by $1,000,000 by selling an additional 360,000 shares of stock. The firm’s tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $866,000. Calculate the change in the firm’s EPS from this change in capital structure. (Do not round intermediate calculations and round your final answers to 2 decimal places.)

Answer 1

solution: Calculation of original EPS EBIT = $ 866,000 Total Debt = $ 2660,000 interest Rate = 8% OR 0.08 Total shares outstanding= 560,000 Shares. Tax Rate=21% . Now, we will comprise the original EPS (A) EBIT $066,000 $ 212,800 $653,200 (B) interest exito (0.00$2660,000) (C) EBT(A-B) (D) tesi Taxes : . : (0.21% $653,200) $137,172 $5.16,020 (E) Net Incomes (F) NO. 4 Shades outstanding 560000 shares. (6) Eps - Net Income (E) - = $516020 No. of shares outstanding 560000 EPS = 0.921770.92 longinal. EAS $0.92 (F) V.

= $1660,000 Calculation of New EPS. Now there are 360000 mase share issued So. Toral Number of shares = 560000 Shares + 36000 Ostaxes, = 920000 shares. Debt has been reduced to ($2660,000 – $1,000,000) Now, we will compite the new EPS (A) EBIT $ 066,000 (B) interest exk $ 132,800 10.08 x $1660,000) $ 733,200 $153972 $ 579228 (C) EBT (A-B) (D) Len: Taxes 10.21% $733,200) > (E). Net Income (F). No. of Shaizes outstanding 920000 $579,228 Net Income rares outstandira .. Nou --0-629-.63 New EPS $0.63 22