Consider a firm with an EBIT of $856,000. The firm finances its assets with $2,560,000 debt...

Consider a firm with an EBIT of $856,000. The firm finances its assets with $2,560,000 debt (costing 8.1 percent and is all tax deductible) and 460,000 shares of stock selling at $7.00 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 260,000 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 $856,000.

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.)

Expert Solution

	Before capital structure change		After capital structure change
EBIT	856,000.00		856,000.00
-Interest ($2,560,000*8.1%)	207,360.00	-Interest ($1,560,000*8.1%)	126,360.00
EBT	648,640.00		729,640.00
-Tax @ 21%	136,214.40		153,224.40
Net income	512,425.60		576,415.60
/no. of shares	460,000.00	460,000+260,000 = 720,000	720,000.00
EPS	1.1140		0.8006

Change in EPS = 1.1140-0.8006 = 0.3134

Thus change in EPS = 1.1140 - 0.8006

= 0.3134

The answer in 2 decimal place will be = 0.31

jeff jeffy answered 2 years ago

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