Question

Consider the following information regarding Pink Tartan Inc. Number of units produced 1,000,000 Total fixed cost $250,000 Per unit variable cost $0.32 Interest on outstanding debt $400,000 Per unit selling price $3.80 Pink Tartan Inc. has 1,000,000 shares outstanding currently selling in the market for $10. The firm is evaluating a new project that would require an initial investment of $2,400,000. To raise the additional $2,400,000, the firm is considering two alternatives: (6) Debt: sell $2,400,000 worth of bonds that would carry a 14% coupon rate. Equity: sell $2,400,000 worth of new shares that would net the firm $16 per share. What level of EBIT would yield the same EPS for the above alternatives? What EPS corresponds to this level of EBIT?

Answer 1

Base

No. of units 1000000

Selling price 3.80

Variable cost 0.32

Contribution 3480000

Fixed cost 250000

EBIT 3230000

Interest cost 400000

EBT 2830000

No. of shares 1000000

EPS 2.83

No. of new shares 150000 (2400000/16)

Investment through debt Investment through equity

EBIT 2576000 2576000

Bond 2400000 0

Interest 336000 0

EBT 2240000 2576000

No. of shares 1000000 1150000

EPS 2.24 2.24

So EBIT should be 2576000 & corresponding EPS = 2.24