Question

Consider a firm with an EBIT of 5857,000. The firm finances its assets with $2.570,000 debt (costing 8.2 percent and is all tax deductible) and 470.000 shares of stock selling at $800 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 270,000 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 5857000 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.) EPS before EPS after Difference

Answer 1

Capital Structure Items Current Debt 2,570,000 Common Stock (470,000 shares) 3,760,000 New Issue of stock (270,000 shares) 6,330,000 Proposed 1,570,000 3,760,000 2,160,000 7,490,000 Total

Evaluation of Proposals Particulars Current Proposed 857,000 EBIT 857,000 210,740 Less: Interest 128,740 (2,570,000 * 8.2%) (1,570,000 * 8.2%) EBT 646,260 728,260 Less: Taxes 135,715 152,935 (EBT * 21%) (EBT * 21%) 510,545 470,000 EAT / Net Income Number of shares EPS (EAT / Number of shares) Difference 575,325 740,000 0.78 1.09 0.31

EPS Before = 1.09

EPS After = 0.78

Difference 0.31

By reducing the debt in the capital structure EPS fell to $0.78 from $1.09.