Question

Oak Farms is an unlevered firm with 2050 shares outstanding and an EBIT of 750. Corporate earnings are taxed at a rate of 31%.

Calculate EPS for Oak Farms. $ Note: Your answer should be in dollars and cents. For example, $0.99.

Suppose that Oak Farms makes a decision to partition (split) its assets into debt and equity. The firm issues $1450 of debt at a cost of 7.55%, and uses these funds to reduce the amount of equity on its books. The partition does not change the EBIT or the tax rate, but does reduce the number of shares outstanding to 1300.

Compute Oak Farms EPS after the partition. $ Note: Your answer should be in dollars and cents.

You Must Get Both Parts Correct to Receive Credit

Answer 1

Solution :-

( A) In case of Unlevered firm ( Which means there is no debt in the company. )

Income Statement
Earning Before Interest and tax ( EBIT )		$750
Less :- Interest		0
Earning Before Tax ( EBT )		$750
Less :- Tax @ 31%		$232.50
Earning After Tax		$517.5
Number of Shares		2050
Earning Per Share ( EPS )		$0.25

EPS = ( Earning After tax / Number of Shares ) = $517.5 / 2050 = $0.25

(B)

Now the firm is levered means there is debt and equity both

Interest Expense = $1450 * 7.55% = $109.475

Income Statement
Earning Before Interest and tax ( EBIT )		$750.00
Less :- Interest ($1,450 * 7.55% )		$109.48
Earning Before Tax ( EBT )		$640.53
Less :- Tax @ 31%		$198.56
Earning After Tax		$441.96
Number of Shares		1300
Earning Per Share ( EPS )		$0.34

Now in case of levered firm EPS = $0.34 per share

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