Question

Fresh out of Harvard Business​ School, John​ Thompson, the new CFO of​ Joe's Southern Cornbread​ Company, wants to shake things up at the sleepy little food company headquartered in​ Birmingham, Alabama. The firm is currently an all minus −equity firm because​ "that's the way​ we've always done​ it." Under pressure from a new group of major​ stockholders, however, Walker is considering acquiring some debt​ (leverage) in an effort to boost earnings per share. The company currently has 8000 shares of common stock​ outstanding, but he is thinking about borrowing​ $16,000 at​ 8% per year and buying back 2000 of those shares. John Thompson is currently living in a world with no taxes. Refer to the scenario above. If Southern​ Cornbread's EBIT is​ $6,000, compare EPS before and after the new debt.

A. All minus −equity EPS​ = $0.787, leveraged minus −equity EPS​ = $0.75

B. All minus −equity EPS​ = $4.50, leveraged minus −equity EPS​ = $3.00

C. All minus −equity EPS​ = $0.75, leveraged minus −equity EPS​ = $0.787

D. All minus −equity EPS​ = $3.00, leveraged minus −equity EPS​ = $4.50

Answer 1

	All Equity	Leveraged equity
EBIT	$             6,000	$           6,000
Interest = 16000*8% =		$           1,280
NI	$             6,000	$           4,720
Number of equity shares	8000	6000
EPS	$             0.750	$           0.787
Answer: C. All equity EPS​ = $0.75, leveraged equity EPS​ = $0.787