Question

Reliable Gearing currently is all-equity-financed. It has 12,000 shares of equity outstanding, selling at $80 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $200,000 with the proceeds used to buy back stock. The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 8%. The firm pays no taxes.

a.	What will be the debt-to-equity ratio after each possible restructuring? (Round your answers to 2 decimal places.)
	D/E (low)?
	D/E (high)?

b.	If earnings before interest and tax (EBIT) will be either $52,000 or $170,000, what will earnings per share be for each financing mix for both possible values of EBIT? (Round your answers to the nearest cent.)
	EPS ($52,000; low-debt plan)    $?
	EPS ($170,000; low-debt plan)    $?
	Expected EPS (low-debt plan)     $?

	If both scenarios are equally likely, what is expected (that is, average) EPS under each financing mix? (Round your answers to the nearest cent.)
	EPS ($52,000; high-debt plan)     $?
	EPS ($170,000; high-debt plan)     $?
	Expected EPS (high-debt plan)    $?

	Is the high-debt mix preferable?
	It is not necessary preferableIt or it is undoubtedly preferable

c.	Suppose that EBIT is $76,800. What is EPS under each financing mix? (Round your answers to the nearest cent.)
	EPS (low-debt plan)      $?
	EPS (high-debt plan)     $?

Answer 1