Consider a firm with an EBIT of $1,001,000. The firm finances its assets with $4,520,000 debt...

Consider a firm with an EBIT of $1,001,000. The firm finances its assets with $4,520,000 debt (costing 8.1 percent) and 201,000 shares of stock selling at $15.00 per share. To reduce risk associated with this financial leverage, the firm is considering reducing its debt by $2,520,000 by selling additional shares of stock. The firm is in the 40 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $1,001,000.

Calculate the EPS before and after the change in capital structure and indicate changes in EPS. (Negative answer should be indicated by a minus sign. Round your answers to 2 decimal places.)

EPS BEFORE
EPS AFTER

DIFFERENCE

Expert Solution

	Before Capital Structure Change	After Capital Structure Change
EBIT	1,001,000.00	1,001,000.00
Less: Interest	366,120.00	162,000.00
EBT	634,880.00	839,000.00
Less: Taxes - 40%	253,952.00	335,600.00
Net Income	380,928.00	503,400.00
No. Of Shares	201,000.00	369,000.00
EPS	1.90	1.36

Change in Capital Structure would decrease the Stockholders EPS by $0.53 ($1.90 - $1.36)


Interest:
Before Capital Structure Change = $4,520,000 X 8.10% = $366,120
After Capital Structure Change = $2,000,000 X 8.10% = $162,000

No. of Shares after Capital Structure Change = 201,000 Shares + ($2,520,000 / $15)
No. of Shares after Capital Structure Change = 201,000 Shares + 168,000 Shares
No. of Shares after Capital Structure Change = 369,000 Shares

ekkarill92 answered 2 years ago

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