Question

In: Finance

Consider a firm with an EBIT of $10,900,000. The firm finances its assets with $50,800,000 debt...

Consider a firm with an EBIT of $10,900,000. The firm finances its assets with $50,800,000 debt (costing 6.9 percent) and 10,400,000 shares of stock selling at $10.00 per share. The firm is considering increasing its debt by $25,400,000, using the proceeds to buy back 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 $10,900,000.

Calculate the EPS before and after the change in capital structure and indicate changes in EPS.

Expert Solution

1. Computation of Number of shares purchased:

Value of company after repurchase = Current value of equity + Total Value of debt * Tax rate

Value of company after repurchase = 10400000 * 10 + (50800000 + 25400000) * 40%

Value of company after repurchase = 104000000 + 30480000

Value of company after repurchase = $134480000

Value of equity after repurchase = Value of company after repurchase - value of debt

Value of equity after repurchase = 134480000 - 76200000

Value of equity after repurchase = 58280000

Share price after repurchase = Value of equity / Shares O/s before repurchase = 58280000 / 10400000 = $5.604

Number of Shares repurchased = amount raised / share price = 25400000 / 5.604

Number of Shares repurchased = 4532601.24 shares

Shares O/s after repurchase = Current shares - shares repurchased

Shares O/s after repurchase = 10400000 - 4532601.24

Shares O/s after repurchase = 5867398.76 Shares

2. Change in EPS

Due to introduction of additional debt EPS increased from $0.43 to 0.58

jeff jeffy answered 1 year ago

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...

Consider a firm with an EBIT of $565,000. The firm finances its assets with $1,150,000 debt...

Consider a firm with an EBIT of $565,000. The firm finances its assets with $1,150,000 debt (costing 5.9 percent) and 215,000 shares of stock selling at $14.00 per share. The firm is considering increasing its debt by $900,000, using the proceeds to buy back 90,000 shares of stock. The firm is in the 30 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $565,000. Calculate the...

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...

XYZ firm has EBIT of $33 and assets of $200. The firm's debt carries an interest...

XYZ firm has EBIT of $33 and assets of $200. The firm's debt carries an interest rate of 6% and the firm has $1.90 of debt for every dollar of equity. The firm's tax rate is 34%. What is the firm's ROE? 21.98% 24.35% 24.06% 23.07% Firm A uses debt and has $550 in equity. Firm B does not use debt and has $1,050 in equity. Both firms pay a 39% tax rate and both firms have EBIT of $54....

A firm has Sh. 4 million of 7.5 % interest rate debt. Its expected EBIT is...

A firm has Sh. 4 million of 7.5 % interest rate debt. Its expected EBIT is Sh. 0.9 million and its cost of equity is 10 %. All assumptions of the Net Income theory apply. Required: a) Calculate the value of the firm using the Net Income approach b) Calculate the cost of capital for the firm the Net Income approach c) Estimate the value of the firm and the cost of capital if the amount of debt is changed...

Leverage ratios (Debt / Total assets) EBIT = 2,500,500 0% 25% 50% Total assets $

Leverage ratios (Debt / Total assets) EBIT = 2,500,500 0% 25% 50% Total assets $ 10,000,000 $ 7,500,000 $ 5,000,000 Debt (12%) 0 $ 2,500,000 $ 5,000,000 Equity $ 10,000,000 $ 10,000,000 $ 10,000,000 Total liabilities and equity $ 10,000,000 $ 12,500,000 $ 15,000,000 Expected operating income (EBIT) $ 2,500,000 $ 2,500,000 $ 2,500,000 Less: Interest (@ 12%) 0 $ 300,000 $ 600,000 Earnings before tax $ 2,500,000 $ 2,200,000 $ 1,900,000 Less: Income tax @ 40% $ 1,000,000 $ 880,000 $ 760,000 Earnings after tax $ 1,500,000 $ 1,320,000 $ 1,140,000 Return on equity 15% 13.20% 11.40% Effect of a...

Consider an all-equity firm with 125,000 shares outstanding. Assume that EBIT=800,000 and that EBIT will remain...

Consider an all-equity firm with 125,000 shares outstanding. Assume that EBIT=800,000 and that EBIT will remain constant, the firm pays out all profits (EPS = dividends per share) as dividends, and that its tax rate is 40%. If the firm’s beta is 1.1, the risk-free rate is 4%, and the market risk premium is 6%, what is the firm’s stock price according to the dividend growth model? Round your answer to the nearest cent.

For a levered firm, firm’s assets are financed by equity and debt. That is, ?? =...

For a levered firm, firm’s assets are financed by equity and debt. That is, ?? = ?? + ?? , where ?? ,?? & ?? represents asset value, debt value and equity value at time ?. Suppose the firm makes no dividend payment and has a zero-coupon debt maturing at time ?. At maturity, if the value of the company asset is greater than the maturity value of the debt (?? > ??), the company will simply pay off the...

A firm currently finances its operations with $50M of equity at a required return of 15%...

A firm currently finances its operations with $50M of equity at a required return of 15% and $50M of bonds at an annual coupon rate of 9%. The firm is considering issuing another $10M of bonds (with the same coupon rate) to retire some equity. (A) What is the firm’s current cost of capital? What do you expect firm’s cost of capital to be after the recapitalization? (B) What do you expect the firm’s cost of equity to be after...

A particular company has no debt outstanding, total assets of $8,000,000 (book value=market value), EBIT of...

A particular company has no debt outstanding, total assets of $8,000,000 (book value=market value), EBIT of $1,600,000, and a cost of equity of 14%. The price of the company’s stock is $20 per share, the number of shares outstanding is 400,000, and the tax rate for the company is 40%. In an adjustment to its capital structure, the company is considering selling bonds and simultaneously repurchasing some of its stock. If the company moves to a capital structure with 40%...