Question

In: Finance

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.)

Solutions

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


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