Firm A wants to finance $5 million to support its new strategic plan. The firm expects that it will be able to generate $2 million in EBIT in the first year of implementing the strategy. The current stock price of Firm A is $10 and it has 1 million shares outstanding. The firm expects that it will be able to borrow money at 7% annual interest. Tax rate is 30%.
Answer the following questions.
1. Firm A also wants to consider combining debt and equity financing methods. If the firm goes for 20% debt and 80% equity to raise the target amount, what is the resulting EPS?
| Computation of EPS | ||||
| Particulars | Amount in $ | |||
| a | Expected EBIT | 2,000,000.00 | ||
| b | Interest (7%*1000000) | 70,000.00 | ||
| c | Profit before tax (a-b) | 1,930,000.00 | ||
| d | Tax@30% (c*30%) | 579,000.00 | ||
| e | Profit after tax (c-d) | 1,351,000.00 | ||
| f | shares outstanding | 1,000,000.00 | ||
| g | EPS (e/f) | 1.35 | ||
| debt= | 5000000*20% | |||
| 1,000,000.00 | ||||
| Note: We have assumed that the company has not distributed divdends as no such information is given in the question and hence entire profit is available to the shareholders. | ||||
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