Question

The U (Unleveraged) company presents the following information: (a) Expected EBIT=50 000; (b) Standard Deviation of EBIT=40 000; (c) Number of common stock=20 000; d) EPS =1.50; (e) Standard Deviation per share of common stock=1.20; and (f) Tax rate = 40%. The above company is just about to change its capital structure by replacing 75% of its common stock with $150 000 of new Debt at 12% annual rate. First make the Income Statement for the Leveraged Company, starting with EBIT=50 000 and ending with EPSL = ?

For the next item, assume that he above company will have zero future growth of EBIT and that the required annual return on the Unleveraged stock is 15%. Now the market value per share of the Leveraged stock is ????

Answer 1

U company
Current no of outstanding shares =	20,000
No of shares outstanding after debt issue=(25% left)=	5,000
Amount od debt	150,000
Annual Interest @12%	18,000
Income statement for leveraged Company
Details	Amt $
EBIT	50,000
Less Interest	18,000
EBT=	32,000
Tax @ 40%	12,800
PAT =	19,200
No of shares Outstanding	5,000
EPS =19200/5000=	$                          3.84
Assuming 100% dividend payout , Dividend /share=	$                          3.84
Cost of leverage equity =15%
So Market Price of share =Dividend/Cost of equity=3.84/15%=	$                        25.60