River Cruises is all-equity-financed with 100,000 shares. It now proposes to issue $250,000 of debt at...

River Cruises is all-equity-financed with 100,000 shares. It now proposes to issue $250,000 of debt at an interest rate of 10% and to use the proceeds to repurchase 25,000 shares. Suppose that the corporate tax rate is 21%. Calculate the dollar increase in the combined after-tax income of its debt-holders and equity-holders if profits before interest are: (Do not round intermediate calculations.)

a. 75,000

b. 100,000

c. 175,000

what is the increase in cash for for a b and c

Expert Solution

(a) Profit Before Tax is $ 75,000

	EPS Before	EPS After
EBIT	75,000.00	75,000.00
(-) Interest	-	25,000.00
EBT	75,000.00	50,000.00
(-) Tax @ 21%	15,750.00	10,500.00
EAT	59,250.00	39,500.00
No of shares	1,00,000.00	75,000.00
EPS = EAT/ No of shares	0.5925	0.5267

Combined after-tax income of its debt-holders and equity-holders = 25,000*(0.79) + 39,500 = $ 59,250

(b) Profit Before Tax is $1,00,000

	EPS Before	EPS After
EBIT	1,00,000.00	1,00,000.00
(-) Interest	-	25,000.00
EBT	1,00,000.00	75,000.00
(-) Tax @ 21%	21,000.00	15,750.00
EAT	79,000.00	59,250.00
No of shares	1,00,000.00	75,000.00
EPS = EAT/ No of shares	0.7900	0.7900

Combined after-tax income of its debt-holders and equity-holders = 25,000*(0.79) + 59,250 = $ 79,000

(c)Profit Before Tax is $1,75,000

	EPS Before	EPS After
EBIT	1,75,000.00	1,75,000.00
(-) Interest	-	25,000.00
EBT	1,75,000.00	1,50,000.00
(-) Tax @ 21%	36,750.00	31,500.00
EAT	1,38,250.00	1,18,500.00
No of shares	1,00,000.00	75,000.00
EPS = EAT/ No of shares	1.3825	1.5800

Combined after-tax income of its debt-holders and equity-holders = 25,000*(0.79) + 1,18,500 = $ 1,38,250

jeff jeffy answered 1 year ago

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