Question

Your company faces a 35% tax rate and has $267 million in assets, currently financed entirely with equity. Equity is worth $9.70 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as shown below:

State	Pessimistic	Optimistic
Probability of State	.20	.80
Expect EBIT in State	$11.7 million	$51.7 million

The firm is considering switching to a 15-percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure? (Round your intermediate calculations and final answer to 2 decimal places, except calculation of number of shares which should be rounded to nearest whole number.)

Answer 1

Total Assets = $267,000,000

Debt = 15% * Total Assets
Debt = 15% * $267,000,000
Debt = $40,050,000

Interest Expense = 10% * Debt
Interest Expense = 10% * $40,050,000
Interest Expense = $4,005,000

Equity = 85% * Total Assets
Equity = 85% * $267,000,000
Equity = $226,950,000

Number of shares outstanding = Equity / Price per share
Number of shares outstanding = $226,950,000 / $9.70
Number of shares outstanding = 23,396,907

Expected EPS = 0.20 * $0.21 + 0.80 * $1.33
Expected EPS = $1.11