Question

Your company faces a 34% tax rate and has $258 million in assets, currently financed entirely with equity. Equity is worth $8.80 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below: State Pessimistic Optimistic Probability of State .25 .75 Expect EBIT in State $10.8 million $50.8 million The firm is considering switching to a 20-percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? (Round your intermediate calculations and final answer to 2 decimal places, except calculation of number of shares which should be rounded to nearest whole number.)

Answer 1

Total Assets = $258,000,000

Value of Debt = 20% * Total Assets
Value of Debt = 20% * $258,000,000
Value of Debt = $51,600,000

Interest Expense = 9.00% * Value of Debt
Interest Expense = 9.00% * $51,600,000
Interest Expense = $4,644,000

Value of Equity = 80% * Total Assets
Value of Equity = 80% * $258,000,000
Value of Equity = $206,400,000

Number of Shares Outstanding = Value of Equity / Price per share
Number of Shares Outstanding = $206,400,000 / $8.80
Number of Shares Outstanding = 23,454,545

Expected EPS = Probability of Pessimistic Economy * EPS during Pessimistic Economy + Probability of Optimistic Economy * EPS during Optimistic Economy
Expected EPS = 0.25 * $0.17 + 0.75 * $1.30
Expected EPS = $1.02